Auditing case introductor resource manual 4th Auditing case introductor resource manual 4th Auditing case introductor resource manual 4th Auditing case introductor resource manual 4th Auditing case introductor resource manual 4th Auditing case introductor resource manual 4th Auditing case introductor resource manual 4th
Auditing Cases Instructor Resource Manual f our th e d i ti o n Mark S Beasley Frank A Buckless Steven M Glover Douglas F Prawitt not copy or redistribute Prentice Hall Upper Saddle River, New Jersey Ta b l e S e ction o f co n t e n t s Client Acceptance S o l u tion s inc lu de d in t his Section 1.1 Ocean Manufacturing, Inc The New Client Acceptance Decision S e ction Understanding the Client’s Business and Assessing Risk S o l u tion s inc lu de d in t h is Section 2.1 Your1040Return.com 2.2 Dell Computer Corporation 2.3 Flash Technologies, Inc 2.4 Asher Farms Inc 13 Evaluating eBusiness Revenue Recognition, Information Privacy, and Electronic Evidence Issues 25 39 Evaluation of Client Business Risk Risk Analysis and Resolution of Client Issues 49 Understanding of Client’s Business Environment S e ction Professional and Ethical Issues S o l u tion s inc lu de d in t h is Section 3.1 A Day in the Life of Brent Dorsey 3.2 Nathan Johnson’s Rental Car Reimbursement 63 3.3 The Anonymous Caller 3.4 WorldCom 71 3.5 Hollinger International 59 Staff Auditor Professional Pressures Solving Ethical Dilemmas–Should He Pocket the Cash? 65 Recognizing It’s a Fraud and Evaluating What to Do The Story of a Whistleblower 79 Realities of Audit-Related Litigation Instructor Resource Manual — Do Not Copy or Redistribute i Ta b l e o f S e cti on cont e nt s Accounting Fraud and Auditor Legal Liability So l u tio n s i nc lu de d in t his Se c tion 4.1 Enron Corporation and Andersen, LLP 4.2 Comptronix Corporation 99 4.3 Cendant Corporation 4.4 Waste Management, Inc 4.5 Xerox Corporation 127 4.6 Phar-Mor, Inc 89 Analyzing the Fall of Two Giants Identifying Inherent Risk and Control Risk Factors 111 Assessing the Control Environment and Evaluating Risk of Financial Statement Fraud 119 Manipulating Accounting Estimates Evaluating Risk of Financial Statement Fraud 137 Accounting Fraud, Litigation, and Auditor Liability S e cti on Internal Control over Financial Reporting So l u tio n s i nc lu de d in t his Se c tion ii 5.1 Simply Steam, Co 5.2 Easy Clean, Co 5.3 Red Bluff Inn & Café 165 5.4 St James Clothiers 169 5.5 Collins Harp Enterprises 5.6 Sarbox Scooter, Inc 5.7 Société Générale 155 Evaluation of Internal Control Environment 155 Evaluation of Internal Control Environment Establishing Effective Internal Control in a Small Business Evaluation of Manual and IT-Based Sales Accounting System Risks 177 Recommending IT Systems Development Controls 185 Scoping and Evaluation Judgments in the Audit of Internal Control over Financial Reporting 195 How a Low-Risk Trading Area Caused a $7.2 Billion Loss Instructor Resource Manual — Do Not Copy or Redistribute Table S e ction o f t e n t s The Impact of Information Technology S o l u tion s inc lu de d in t h is Section 6.1 Harley-Davidson, Inc 6.2 Jacksonville Jaguars 207 Identifying eBusiness Risks and Related Assurance Services for the eBusiness Marketplace 215 Evaluating IT Benefits and Risks and Identifying Trust Services Opportunities Ot he r c as es t h at d is cuss topics related to thi s s ection 2.1 Your1040Return.com 13 Evaluating eBusiness Revenue Recognition, Information Privacy, and Electronic Evidence Issues 5.4 5.5 9.2 S e ction St James Clothiers 169 Evaluation of Manual and IT-Based Sales Accounting System Risks Collins Harp Enterprises 177 Recommending IT Systems Development Controls Henrico Retail, Inc 279 Understanding the IT Accounting System and Identifying Audit Evidence for Retail Sales Planning Materiality S o l u tion s inc lu de d in t h is Section 7.1 Anne Aylor, Inc 229 Determination of Planning Materiality and Tolerable Misstatement Ot he r c as es t h at d is cuss topics related to thi s s ection 5.6 Sarbox Scooter, Inc 185 Scoping and Evaluation Judgments in the Audit of Internal Control over Financial Reporting 12.1 12.2 EyeMax Corporation 369 Evaluation of Audit Differences Auto Parts, Inc 379 Considering Materiality When Evaluating Accounting Policies and Footnote Disclosures Instructor Resource Manual — Do Not Copy or Redistribute iii Ta b l e o f S e cti on cont e nt s Analytical Procedures So l u tio n s i nc lu de d in t his Se c tion 8.1 Laramie Wire Manufacturing 239 8.2 Northwest Bank 245 8.3 Burlingham Bees Using Analytical Procedures in Audit Planning Developing Expectations for Analytical Procedures 251 Using Analytical Procedures as Substantive Tests Othe r c as es t h at disc u ss topics related to thi s s ection 1.1 Ocean Manufacturing, Inc The New Client Acceptance Decision 2.3 Flash Technologies, Inc 39 Risk Analysis and Resolution of Client Issues S e cti on Auditing Cash and Revenues So l u tio n s i nc lu de d in t his Se c tion 9.1 Wally’s Billboard & Sign Supply 9.2 Henrico Retail, Inc 9.3 Longeta Corporation 9.4 Bud's Big Blue Manufacturing 259 279 The Audit of Cash Understanding the IT Accounting System and Identifying Audit Evidence for Retail Sales 285 Auditing Revenue Contracts 291 Accounts Receivable Confirmations Othe r c as es t h at disc u ss topics related to thi s s ection 8.2 Northwest Bank 245 Developing Expectations for Analytical Procedures 8.3 Burlingham Bees 251 Using Analytical Procedures as Substantive Tests iv Instructor Resource Manual — Do Not Copy or Redistribute S e ction 10 Table o f t e n t s Planning and Performing Audit Procedures in the Revenue and Expenditure Cycles An Audit Simulation S o l u tion s inc lu de d in t h is Section 10.1 Southeast Shoe Distributor, Inc Identification of Tests of Controls for the Revenue Cycle (Sales and Cash Receipts) 10.2 Southeast Shoe Distributor, Inc Identification of Substantive Tests for the Revenue Cycle (Sales and Cash Receipts) 299 309 10.3 Southeast Shoe Distributor, Inc Selection of Audit Tests and Risk Assessment for the Revenue Cycle (Sales and Cash Receipts) 319 333 347 10.4 Southeast Shoe Distributor, Inc Performance of Tests of Transactions for the Expenditure Cycle (Acquisitions and Cash Disbursements) 10.5 Southeast Shoe Distributor, Inc Performance of Tests of Balances for the Expenditure Cycle (Acquisitions and Cash Disbursements) S e ction 11 Developing and Evaluating Audit Documentation S o l u tion s inc lu de d in t h is Section 11.1 The Runners Shop 359 Litigation Support Review of Audit Documentation for Notes Payable Ot he r c as es t h at d is cuss topics related to thi s s ection 9.1 Wally’s Billboard & Sign Supply 259 The Audit of Cash 9.2 Henrico Retail, Inc 279 Understanding the IT Accounting System and Identifying Audit Evidence for Retail Sales 9.3 9.4 10.1-5 Longeta Corporation 285 Auditing Revenue Contracts Bud's Big Blue Manufacturing 291 Accounts Receivable Confirmations Southeast Shoe Distributor, Inc Instructor Resource Manual — Do Not Copy or Redistribute 299 v Ta b l e o f S e cti on cont e nt s 12 Completing the Audit, Reporting to Management, and External Reporting So l u tio n s i nc lu de d in t his Se c tion 12.1 EyeMax Corporation 369 Evaluation of Audit Differences 12.2 Auto Parts, Inc 379 Considering Materiality When Evaluating Accounting Policies and Footnote Disclosures 12.3 K&K Inc 385 Leveraging Audit Findings to Provide Value-Added Insights 12.4 Surfer Dude Duds, Inc Considering the Going-Concern Assumption 12.5 Murchison Technologies, Inc Evaluating an Attorney’s Response and Identifying the Proper Audit Report vi 391 395 Instructor Resource Manual — Do Not Copy or Redistribute Alp h a b e t i c 7.1 3.3 2.4 12.2 9.4 8.3 4.3 5.5 4.2 3.1 2.2 5.2 4.1 12.1 2.3 6.1 9.2 3.5 6.2 12.3 8.1 9.3 12.5 3.2 8.2 1.1 4.6 5.3 11.1 5.6 5.1 5.7 10.1 10.2 10.3 10.4 10.5 5.4 12.4 9.1 4.4 3.4 4.5 2.1 C a s e I n d e x Anne Aylor, Inc 229 Anonymous Caller, The 65 Asher Farms Inc 49 Auto Parts, Inc 379 Bud's Big Blue Manufacturing 291 Burlingham Bees 251 Cendant Corporation 111 Collins Harp Enterprises 177 Comptronix Corporation 99 Day in the Life of Brent Dorsey, A 59 Dell Computer Corporation 25 Easy Clean, Co 155 Enron Corporation and Andersen, LLP 89 EyeMax Corporation 369 Flash Technologies, Inc 39 Harley-Davidson, Inc 207 Henrico Retail, Inc 279 Hollinger International 79 Jacksonville Jaguars 215 K&K Inc 385 Laramie Wire Manufacturing 239 Longeta Corporation 285 Murchison Technologies, Inc 395 Nathan Johnson’s Rental Car Reimbursement 63 Northwest Bank 245 Ocean Manufacturing, Inc Phar-Mor, Inc 137 Red Bluff Inn & Café 165 Runners Shop, The 359 Sarbox Scooter, Inc 185 Simply Steam, Co 155 Société Générale 195 Southeast Shoe Distributor, Inc.: Tests of Controls for the Revenue Cycle 299 Southeast Shoe Distributor, Inc.: Substantive Tests for the Revenue Cycle 309 Southeast Shoe Distributor, Inc.: Audit Tests and Risk Assessment for the Revenue Cycle 319 Southeast Shoe Distributor, Inc.: Tests of Transactions for the Expenditure Cycle 333 Southeast Shoe Distributor, Inc.: Tests of Balances for the Expenditure Cycle 347 St James Clothiers 169 Surfer Dude Duds, Inc 391 Wally’s Billboard & Sign Supply 259 Waste Management, Inc 119 WorldCom 71 Xerox Corporation 127 Your1040Return.com 13 Instructor Resource Manual — Do Not Copy or Redistribute vii P r e fac e Auditing educators are increasing their emphasis on the development of students’ critical thinking, communication, and interpersonal relationship skills Development of these types of skills requires a shift from passive instruction to active involvement of students in the learning process Unfortunately, current course materials provided by many publishers are not readily adaptable to this kind of active learning environment, or not provide materials that address each major part of the audit process The purpose of this casebook is to give students hands-on exposure to realistic auditing situations focusing specifically on each aspect of the audit process The casebook contains a collection of 44 auditing cases that allow the instructor to focus and deepen students’ understanding in each of the major activities performed during the conduct of an audit, from client acceptance to issuance of an audit report The cases are designed to engage the student’s interest through the use of lively narrative and the introduction of engaging issues In some cases, supporting material in the instructor notes allows the instructor to create a “surprise” or “aha!” experience for the student, creating vivid and memorable learning experiences Many of the cases are based on actual companies, some involving financial reporting fraud Several cases give students hands-on experience with realistic audit evidence and documentation Each case contains a series of questions requiring student analysis, with numerous questions related to the guidance contained in several new authoritative auditing standards, including the PCAOB’s Auditing Standard No 5, An Audit of Internal Control Over Financial Reporting that is Integrated with an Audit of Financial Statements, the new “risk assessment standards” issued by the AICPA’s Auditing Standards Board as SAS Nos 104 through 111, and SAS No 112, Communicating Internal Control Related Matters Identified in an Audit, SAS No 113, Omnibus Statement on Auditing Standards – 2006, and SAS No 114, The Auditor’s Communication with Those Charged With Governance Several cases require students to gain a clearer understanding of the specific requirements contained in the Sarbanes−Oxley Act of 2002 Other cases provide additional exposure to the role information technology in today’s assurance environment, including a focus on Trust Services such as SysTrust and WebTrust Finally, some cases use excerpts from transcripts of financial statement fraud trails to illustrate the importance of following audit principles and procedures The cases are suitable for both undergraduate and graduate students At the undergraduate level, the cases provide students with active learning experiences that reinforce key audit concepts addressed by the instructor and textbook At the graduate level, the cases provide students with active learning experiences that expand the depth of their audit knowledge Use of the casebook will provide students with opportunities to develop a much richer understanding of the essential underlying issues involved in auditing, while at the same time developing critical thinking, communication, and interpersonal relationship skills The casebook provides a wide variety of cases to facilitate different learning and teaching styles For example, several of the cases can be used either as in-class exercises or out-of-class assignments This manual clearly illustrates the different instructional approaches available for each case (e.g., examples of cooperative/active learning activities and/or out-of-class individual or group assignments) and efficiently prepares the instructor for leading interactive discussions Please submit any corrections or suggestions to: auditingcases@byu.edu Instructor Resource Manual — Do Not Copy or Redistribute ix f o u r t h e d i t i o n update s to prior c a se s Cases from the prior edition have been updated to reflect changes in professional standards Cases based on events at real companies have been updated to reflect relevant recent developments The Anne Aylor case (7.1), has been updated to reflect industry trends, including updated financial information Dates in the hypothetical cases have been set in calendar year 2009 with audit procedures performed for the 2008 fiscal year and/or interim procedures performed for the 2009 fiscal year N e w t o th e fou rth e d ition The following cases have been added to the fourth edition to expand coverage of audit topics and provide timely coverage of recent high profile accounting-related events x 2.4 Asher Farms Inc 3.5 Hollinger International 5.7 Société Générale 9.4 Bud's Big Blue Manufacturing 49 Understanding of Client’s Business Environment In this case students use the PESTLE analysis tool to assess the client's business environment Students are encouraged to conduct additional internet research in order to complete the case Asher Farms, Inc is a hypothetical company 79 Realities of Audit-Related Litigation This case contains excerpts of actual trial transcripts in which the auditor of Hollinger International addresses several audit concepts including reasonable assurance, audit committee oversight, and audit documentation 195 How a Low-Risk Trading Area Caused a $7.2 Billion Loss This case provides phenomenal details about an actual fraud at France's second largest bank The fraud that led to a $7.2 billion loss was perpetrated by one rogue trader who overrode and eluded internal controls for approximately two years The content provides valuable insights for both audit and information systems courses 291 Accounts Receivable Confirmations This case provides students the opportunity to evaluate the appropriateness and sufficiency of evidence obtained through confirmations of accounts receivable balances and to identify any additional procedures that should be performed Bud's Big Blue Manufacturing is a hypothetical company Instructor Resource Manual — Do Not Copy or Redistribute To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Section 12: Completing the Audit, Reporting to Management, and External Reporting E x h i b it - N ew ( I m p rov ed) Comparison Cost Breakdo w n (Based on Annual Volume of 48,000 Custom Frames and 288,000 Plastic Frames) Custom Frames Size Size Sales Price Small Medium Maple w/ regular $ 32.50 $ 49.50 Maple w/ nonglare 33.50 50.75 Oak w/ regular 35.00 55.50 Oak w/ nonglare 36.00 56.50 Cherry w/ regular 42.75 62.00 Cherry w/ nonglare 43.75 63.00 Total Costs Maple w/ regular $ 30.65 $ 44.70 Maple w/ nonglare 31.15 45.45 Oak w/ regular 34.15 50.30 Oak w/ nonglare 34.65 51.05 Cherry w/ regular 37.90 56.30 Cherry w/ nonglare 38.40 57.05 Margin Maple w/ regular $ 1.85 $ 4.80 Maple w/ nonglare 2.35 5.30 Oak w/ regular 0.85 5.20 Oak w/ nonglare 1.35 5.45 Cherry w/ regular 4.85 5.70 Cherry w/ nonglare 5.35 5.95 Size Large $ 66.00 68.00 73.00 75.00 81.00 83.00 $ 57.40 58.50 64.40 65.50 71.90 73.00 $ 8.60 9.50 8.60 9.50 9.10 10.00 Plastic Frames Size Size Size Sales Price 5X7 8X10 11X14 Tan w/ regular $ 0.70 $ 0.85 $ 1.00 Tan w/ nonglare 0.75 0.90 1.07 Brown w/ regular 0.70 0.85 1.00 Brown w/ nonglare 0.75 0.90 1.07 Black w/ regular 0.70 0.85 1.00 Black w/ nonglare 0.75 0.90 1.07 Total Costs Tan w/ regular $ 0.81 $ 0.88 $ 0.98 Tan w/ nonglare 0.82 0.90 1.01 Brown w/ regular 0.81 0.88 0.98 Brown w/ nonglare 0.82 0.90 1.01 Black w/ regular 0.81 0.88 0.98 Black w/ nonglare 0.82 0.90 1.01 Margin Tan w/ regular $(0.11) $(0.03) $ 0.02 Tan w/ nonglare (0.07) (0.00) 0.06 Brown w/ regular (0.11) (0.03) 0.02 Brown w/ nonglare (0.07) (0.00) 0.06 Black w/ regular (0.11) (0.03) 0.02 Black w/ nonglare (0.07) (0.00) 0.06 If Custom Frames are Discontinued Size Size Size Sales Price 5X7 8X10 11X14 Tan w/ regular $ 0.70 $ 0.85 $ 1.00 Tan w/ nonglare 0.75 0.90 1.07 Brown w/ regular 0.70 0.85 1.00 Brown w/ nonglare 0.75 0.90 1.07 Black w/ regular 0.70 0.85 1.00 Black w/ nonglare 0.75 0.90 1.07 Total Costs Tan w/ regular $ 0.92 $ 0.99 $ 1.09 Tan w/ nonglare 0.93 1.01 1.12 Brown w/ regular 0.92 0.99 1.09 Brown w/ nonglare 0.93 1.01 1.12 Black w/ regular 0.92 0.99 1.09 Black w/ nonglare 0.93 1.01 1.12 Margin Tan w/ regular $(0.22) $(0.14) $(0.09) Tan w/ nonglare (0.18) (0.11) (0.05) Brown w/ regular (0.22) (0.14) (0.09) Brown w/ nonglare (0.18) (0.11) (0.05) Black w/ regular (0.22) (0.14) (0.09) Black w/ nonglare (0.18) (0.11) (0.05) The per unit margin numbers were derived by using the following summarized unit cost data: Custom Frames Size Size Size Small Medium Large $ 9.25 $ 14.80 $ 18.50 12.75 20.40 25.50 16.50 26.40 33.00 Wood Maple Oak Cherry Glass Regular $ 4.50 $ 5.00 $ 6.00 Nonglare 5.00 5.75 7.10 Labor 16.00 24.00 32.00 Overhead per unit $ 0.90 $ 0.90 $ 0.90 Plastic Frames Size Size Size Plastic 5X7 8X10 11X14 Tan $ 0.10 $ 0.15 $ 0.23 Brown 0.10 0.15 0.23 Black 0.10 0.15 0.23 Glass Regular $ 0.06 $ 0.09 $ 0.11 Nonglare 0.08 0.11 0.14 Labor 0.18 0.18 0.18 Overhead per unit $ 0.47 $ 0.47 $ 0.47 If Custom Frames are Discontinued Size Size Size Plastic 5X7 8X10 11X14 Tan $ 0.10 $ 0.15 $ 0.23 Brown 0.10 0.15 0.23 Black 0.10 0.15 0.23 Glass Regular $ 0.06 $ 0.09 $ 0.11 Nonglare 0.08 0.11 0.14 Labor 0.18 0.18 0.18 Overhead per unit $ 0.58 $ 0.58 $ 0.58 NOTE: The numbers above are rounded to the second decimal for presentation purposes; however, the math was performed in Excel without rounding 390 Instructor Resource Manual — Do Not Copy or Redistribute To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Instructor Resource Manual — Do Not Copy or Redistribute Surfer Dude Duds, Inc C a se 12.4 Considering the Going-Concern Assumption Mark S Beasley · Frank A Buckless · Steven M Glover · Douglas F Prawitt INS TR UC T IONAL O b je ctive s [1] To expose students to the behind-the-scenes issues involving going-concern evaluations [2] To illustrate circumstances when an auditor would issue a going-concern explanatory paragraph and the implications of such a modification from the perspective of both the client and the auditor To understand the effect that a going-concern explanatory paragraph has on a company’s struggle for survival—the “self-fulfilling prophecy” effect [4] To highlight the importance of the auditor exercising independent judgment even in light of friendly client-auditor relationships [3] KEY FACTS Surfer Dude Duds, Inc is a clothing and accessories company specializing in the California “surfer” culture The mild economic recession has especially impacted the clothing industry, and analysts forecast that continuing hard times lie ahead Surfer Dude found itself unable to meet all of its financial obligations and the future of the company is in doubt Mark has been the audit partner for Surfer Dude for the last six years, which has helped him develop a strong, personal friendship with George Baldwin, the company CEO During the previous six years on the Surfer Dude audit, the audit report had always indicated a “clean” opinion on the company’s financial statements Mark consulted with his concurring partner on the audit and decided that the only alternative for this year’s audit of Surfer Dude’s financial statements was to add a going-concern explanatory paragraph to the audit report Mark told George of his decision and George replied that a going-concern explanatory paragraph would become a self-fulfilling prophecy that would ultimately damage the company, leading to its failure and the unemployment of Surfer Dude employees USE OF CASE This case is an excellent tool for emphasizing pressures auditors face when trying to balance satisfying their clients with remaining loyal to their duty to the public Class discussion of this case could be centered around the theme of independence and the pressures the auditors feel as they attempt to remain independent of their clients while still maintaining a close, working relationship beneficial to both the client and the audit firm In doing so, the instructor should help students recognize the principal duty of the auditor and the importance of focusing on fulfilling their obligations to protect public interests At the same time, the case also illustrates the reality of close auditor-client relationships that often develop We find that this usually leads to a discussion of how a going-concern explanatory paragraph can negatively impact a company by becoming a “selffulfilling prophecy” in that the going-concern disclosure casts such doubt about the company that This case was prepared by Mark S Beasley, Ph.D and Frank A Buckless, Ph.D of North Carolina State University and Steven M Glover, Ph.D and Douglas F Prawitt, Ph.D of Brigham Young University, as a basis for class discussion The case was inspired by discussions with Craig Isom, a former audit partner, and we gratefully acknowledge his contribution to its development Surfer Dude Duds is a fictitious company All characters and names represented are fictitious; any similarity to existing companies or persons is purely coincidental Copyright © 2009 by Pearson Education, Inc., Upper Saddle River, NJ 07458 391 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Section 12: Completing the Audit, Reporting to Management, and External Reporting stakeholders (e.g., creditors, customers) no longer engage in transactions with the client The inclass discussion should also highlight the fact that full and complete disclosure is the best approach for both the auditor and the client PROFESSIONAL STANDARDS Relevant professional standards for this assignment include AU Section 220, “Independence,” AU Section 341, “The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern,” ET Section 53, “Article II-The Public Interest,” ET Section 55, “Article IV-Objectivity and Independence,” and ET Section 101, “Independence.” SU G G E S TE D S OLU T IO N [1] What are Mark’s options? The first option available to Mark is to withdraw as the partner in charge of the audit if he feels his objectivity is in any way compromised If he feels unsure about his ability to make a judgment with complete objectivity and professionalism, he could withdraw from the audit and allow another partner to deal with Surfer Dude and issue the appropriate audit report Another possibility for Mark is to not include a going-concern paragraph in the audit report with the hope that it would allow Surfer Dude the opportunity to improve their worsening financial condition This option would satisfy Mark’s desire to help Surfer Dude by not causing them any possible further damage But by doing so, Mark may be compromising his duty to the public whose interests he is obligated to protect Such actions could lead to serious negative consequences for the public, for the profession, for Mark’s firm, and for Mark himself if Surfer Dude ultimately fails A third option available to Mark is to include a going-concern explanatory paragraph in the audit report He would so at the risk of losing his friendship and future business relationship with George and Surfer Dude In addition, Mark knows that the issuance of a going-concern report modification could further limit the likelihood of Surfer Dude overcoming their financial difficulties It may be possible for Mark to delay issuing an opinion on the audited financial statements for a few weeks until further information is available as to whether Surfer Dude will be successful in obtaining new financing or resolving in some other way the substantial doubt about the entity’s ability to continue in existence during the coming year This is clearly not a permanent resolution, but may provide time for some of the doubts to be resolved one way or the other [2] How might a going-concern explanatory paragraph become a “self-fulfilling prophecy” for Surfer Dude? George Baldwin’s emotional plea to Mark is that the issuance of a going-concern explanatory paragraph would eventually put them out of business Creditors would not want to loan them more money and may even withdraw existing credit, vendors might require C.O.D on purchases, and customers may not buy from them out of fear that Surfer Dude may not stand behind its sales return policy In fact, it is quite possible that a going-concern explanatory paragraph could cause such a reaction By stating to the public that the ability of this company to continue as a going concern is in doubt, many key stakeholders (suppliers, customers, creditors, shareholders, and employees) might react in ways to protect their own interests that would be adverse to Surfer Dude’s viability Unless they look beyond the going-concern modification and believe the company will pull out of the hard times, stakeholder reaction to the auditor’s report could make the company’s chances of survival even slimmer 392 Instructor Resource Manual — Do Not Copy or Redistribute To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Case 12.4: Surfer Dude Duds, Inc [3] What potential implications arise for the accounting firm if they issue an unqualified report without the going-concern explanatory paragraph? The implications for the audit firm that could arise if a clean opinion is issued should be one of Mark’s major concerns in this case First, if a clean opinion is issued and Surfer Dude reverses the negative trends as George predicts, then Mark’s firm will be able to continue in a friendly working-relationship with Surfer Dude, and there will be little, if anything, in the way of negative consequences However, if the company fails to continue as a going concern within the next year and the auditor fails to report such a possibility in advance, then the auditor faces an increased risk of liability to the stakeholders who relied upon the firm’s audit report This possibility has the potential to be extremely expensive and damaging to the firm’s credibility There are also potential implications for the public, for Mark, and for the auditing profession as a whole [4] Discuss the importance of full and accurate auditor reporting to the public, and describe possible consequences for both parties if the going-concern explanatory paragraph and footnote are excluded How might Mark convince George that a going-concern report is in the best interests of all parties involved? The auditor’s primary duty is to report accurately and fully to the public Independent auditors must always act to protect the best interests of the public The value of the auditing profession is grounded on the public’s trust that the auditor is reporting honestly and objectively When auditors fail to meet this expectation, the public’s trust in them is damaged and the value of the audit is undermined To convince George that a going-concern opinion is the best option for all parties, Mark must help him see the possible negative results as well as the potential benefits to George’s company On the surface, George believes that the absence of a going-concern explanatory paragraph would allow Surfer Dude the opportunity to recover from their financial difficulties But in reality, by not issuing such an opinion they could face much more serious consequences Surfer Dude also has an obligation to accurately report their financial condition to the public and its stakeholders Failing to so could expose George and his company to a greater amount of potential liability from potential lawsuits from the company’s stakeholders It is true that a going-concern report modification will publicly highlight the difficulties that Surfer Dude is experiencing and therefore make other business transactions more difficult However, the consequences of not reporting fully and completely are potentially much more negative than those associated with not disclosing the going-concern issue Mark must help George realize that full disclosure to the company’s stakeholders is in his and his company’s best interest [5] Is it appropriate for an audit partner to have a friendly personal relationship with a client? At what point could a personal relationship become an independence issue? The AICPA Code of Professional Conduct does not prohibit audit partners from having personal friendships with their clients In fact, audit firms routinely expend considerable resources in strengthening professional ties and relationships, including with clients and prospective clients As long as such relationships not impair the independent judgment of the auditor, it would not be considered inappropriate The key, however, is that the relationship must not affect the independence (in fact or in appearance) of the auditor If the audit partner begins to feel as a result of his relationship with the client a stronger commitment to the client than to the public, the partner should withdraw from the engagement To some extent, the requirement for the involvement of a quality review partner on every audit engagement is designed to help ensure that the engagement partner is not “too close” to the situation to be completely objective Instructor Resource Manual — Do Not Copy or Redistribute 393 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Section 12: Completing the Audit, Reporting to Management, and External Reporting [6] What factors might motivate Mark to be objective in his decision, despite his personal concern for his friend? There are several factors present that encourage Mark to be impartial in his decision However, the most important factors are his personal integrity, his commitment to his firm, and his duty to the public Mark can not allow himself to be influenced by his personal concern for his friend or his fear of losing a client His duty as an auditor is to protect the interests of the public Failing to so could result in serious negative consequences, including possible litigation and loss of reputation, for himself and his audit firm These loyalties to the public and his firm should motivate Mark to remain completely objective in his decision [7] In your opinion, what should Mark do? Briefly justify your position Students may express a variety of opinions, but the best option is for Mark to remain completely objective in his audit opinion If the going-concern explanatory paragraph is the most accurate representation of the company’s financial condition, then Mark is obligated to report his substantial doubt about the company’s ability to continue In doing so, he must help George see the possible benefits that could come of this explanatory paragraph and the possible negative results of failing to include the explanatory paragraph 394 Instructor Resource Manual — Do Not Copy or Redistribute To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Instructor Resource Manual — Do Not Copy or Redistribute Murchison Technologies, Inc C a se 12.5 Evaluating an Attorney’s Response and Identifying the Proper Audit Report Mark S Beasley · Frank A Buckless · Steven M Glover · Douglas F Prawitt INS TR UC T IONAL O b je ctive s [1] To illustrate proper accounting treatment for loss contingencies [2] To provide an opportunity for students to evaluate how different attorney judgments about loss contingencies affect auditor reporting To highlight the nature and timing of attorney confirmation letters to auditors [4] To illustrate how attorney confirmation responses affect the auditor’s evaluation of a client’s accounting for contingencies [3] KEY FACTS • This case involves Murchison Technologies, Inc which is a hypothetical developer of a patient-billing software system marketed as MEDTECH Software • The accounting firm of Custer and Custer, LLP, was first engaged to review Murchison’s financial statements four years ago For the past two years, the audit firm audited the company’s year-end financial statements and issued standard, unqualified reports on those statements The audit firm is in its third year of serving as auditor • Custer and Custer, LLP, is completing the audit of the December 31, 2008 financial statements As part of the final audit procedures, a confirmation request was sent to Murchison’s outside legal counsel asking for the standard attorney confirmation about material outstanding claims against Murchison • Based on discussions with the client, Custer and Custer does not expect any substantive litigation issues to be identified in the attorneys’ responses The auditor’s only litigation concern is the alleged copyright infringement apparently filed against Murchison in October 2008 • The audit firm’s review of the board of directors’ minutes and discussions with management indicate that the probability of unsuccessful outcome is extremely low • The litigation case involves another software developer, Physicians Software, Inc., who claims that Murchison’s MEDTECH Software violates a copyright held by Physicians Software They are suing Murchison for $220,000 • Management believes the suit is immaterial in light of Murchison’s total assets of $7 million on December 31, 2008 and total revenues and pretax income of $22 million and $1.8 million, respectively, for the year then ended • Custer & Custer received all three requested attorney confirmation responses Two of those responses provided no surprises However, the third response, which is provided in the student’s case materials, is puzzling The attorney states that they believe the likelihood of a negative outcome is more than remote but less than likely, with possible ranges of loss extending from $150,000 to $200,000 The case was prepared by Mark S Beasley, Ph.D and Frank A Buckless, Ph.D of North Carolina State University and Steven M Glover, Ph.D and Douglas F Prawitt, Ph.D of Brigham Young University, as a basis for class discussion Murchison is a fictitious company All characters and names represented are fictitious; any similarity to existing companies or persons is purely coincidental Copyright © 2009 by Pearson Education, Inc., Upper Saddle River, NJ 07458 395 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Section 12: Completing the Audit, Reporting to Management, and External Reporting USE OF CASE This case is appropriate when discussing auditor reports and completing the audit Some instructors cover audit reports early in the course, while others discuss audit reports at the end This case will work for either approach Instructors planning to use this case early in the course should briefly discuss the purpose and typical timing of attorney letters or refer students to the relevant textbook section discussing attorney confirmation letters Given that the use of attorney confirmation letters is a relatively easy concept for students to understand, covering them early in the semester should not pose much difficulty Other instructors may chose to wait to cover this case when discussing final stage audit procedures Since the case requires a review of accounting issues related to contingencies, we suggest having students read the background material in advance of any in-class discussion of the case While the background material is not lengthy, having students read the material during the class period may require too much valuable in-class time Additionally, some of the American Bar Association information included in the student materials contains some legal terminology, which may be difficult reading for some students Having time outside class to digest that material should be beneficial Furthermore, the first question requires students to summarize relevant accounting guidance related to contingencies Some students may need to refer to a current text of professional standards or an intermediate accounting text to answer that question Once students have an opportunity to consider the background information, the case can easily be completed as an in-class group assignment A useful in-class activity is to have students answer all questions in small four-person groups Alternatively, the instructor may assign each group a different question Given that question provides six different scenarios related to auditor reporting about this litigation case, instructors may find it especially helpful to assign each group a different scenario described in questions 4.a through 4.f Once each group has had time to answer the assigned questions, the class can reconvene to discuss the various group solutions Instructors can call on students to report their group’s solutions orally during class The instructor should randomly call on individual students to share their group’s answers to ensure that all students take responsibility for learning the material This case can also be used as an out-of-class assignment that can be completed in groups or individually An out-of-class activity could simply involve having students or groups prepare typed solutions to each of the questions On the day the solutions are due, a portion of the class should be devoted to reviewing student answers If the written solutions are individually completed, students can be divided into small groups of three-to-five individuals to share their solutions with other group members This case is also appropriate for a senior seminar or capstone accounting course, since the case blends financial accounting and auditor reporting issues One way to increase the emphasis of the financial reporting issues is to require students to prepare a draft of the related financial statement footnote disclosure, assuming the loss contingency was considered reasonably possible and material The solution to question provides a brief overview of the required content of the footnote disclosure Another way to modify the case is to ask students how the auditor would be impacted if the litigation case was not filed against Murchison until after the completion of evidence gathering procedures but before the audit report was issued PROFESSIONAL STANDARDS Relevant professional standards for this assignment include AU Section 312 “Audit Risk and Materiality in Conducting an Audit,” AU Section 337 “Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments, AU Section 508, “Reports on Audited Financial Statements,” and Statement of Financial Accounting Standards No 5, “Accounting for Contingencies.” 396 Instructor Resource Manual — Do Not Copy or Redistribute To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Case 12.5: Murchison Technologies, Inc Q U E S TI ONS AND SU GG EST ED SOL UTION S In this case, students are required to evaluate the attorney’s confirmation response letter in light of the background information provided Specifically, students are asked to identify the correct audit report that should be issued for a variety of changing circumstances surrounding the outstanding claim [1] Review the requirements of Statement of Financial Accounting Standards (SFAS) No 5, Accounting for Contingencies Describe the three ranges of loss contingencies outlined in SFAS No and summarize briefly the accounting and disclosure requirements for each of the three ranges Exhibit I of AU Section 337 presents excerpts from SFAS No that describe these three ranges of loss contingencies, which range from probable to remote: Probable – The future event or events are likely to occur Reasonably possible – The chance of the future event or events occurring is more than remote, but less than likely Remote – The chance of the future event or events occurring is slight Exhibit I of AU Section 337 also notes that SFAS No requires that an estimated loss from a loss contingency must be accrued by a charge to income if both of the following conditions are met: a Information available prior to the issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements b The amount of the loss can be reasonably estimated Disclosure in the footnotes to the financial statements must be made when there is at least a reasonable possibility that a loss or an additional loss will be incurred The disclosure shall indicate the nature of the litigation, progress of the case, how management will respond, likelihood of unfavorable outcome, and an estimate of the possible range of loss or state that such an estimate cannot be made No disclosure is necessary if the likelihood of the loss contingency is assessed as remote [2] Based on your review of the attorney’s confirmation, which of the three ranges of probability of loss you think the Physicians Software, Inc., claim falls? How does that assessment differ from management’s assessment of the loss probability? Given that the attorney’s response explicitly states that they believe “the likelihood of negative future outcome occurring against Murchison in this case is more than remote but less than likely,” the case appears to fall into the reasonably possible range of loss That assessment is in conflict with management’s assessment of the outcome Custer and Custer’s review of Murchison’s board of directors’ minutes and their discussions with management both indicated that management viewed the likelihood of a negative outcome to be in the remote likelihood of loss [3] Assuming that management and the attorney’s assessments differ, how would you resolve such differences when assessing the potential for an unfavorable outcome associated with the claim? What are the pros and cons of relying on the attorney’s assessment versus management’s assessment? As a first step, the auditors should provide management with a copy of the attorney’s response letter Given that management is responsible for the financial statements, it is management’s responsibility to resolve this financial reporting issue with its outside attorney Perhaps management and their attorney have failed to share relevant information with one another Instructor Resource Manual — Do Not Copy or Redistribute 397 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Section 12: Completing the Audit, Reporting to Management, and External Reporting about the case, which might explain differences in their assessments of the likely outcome The auditor can help facilitate these discussions; however, ultimately it is management’s responsibility to prepare the financial statements and related disclosures The advantage of relying on the attorney’s assessment is that the auditor is able to rely on evidence obtained from an external party who is an expert in assessing legal claims Given the subjective nature of evaluating loss contingencies, there is significant potential for management’s bias to affect (either intentionally or unintentionally) their judgment about the likely outcome of the case Naturally, the potential negative effect on pretax earnings associated with accounting for and disclosing loss contingencies provides an incentive for management to under assess the potential for loss As a result, seeking the advice of an outside legal expert offers tremendous advantage to the auditor since the attorney’s assessment should be more objective than management’s Additionally, outside attorneys have extensive legal training and experience So, the outside attorney is likely to be more objective and more qualified to make loss contingency assessments than management One disadvantage of relying on the assessment of the outside legal counsel is that they may be more conservative in making their assessment than management An outside attorney may prefer to err on the side of conservatism when providing legal assessments to external auditors to minimize legal liability Another potential disadvantage of relying on the outside attorney’s assessment is that the assessment may not be completely reliable because the attorney has not received the most up-to-date and complete information about the case from management This disadvantage is most acute when management and the outside attorney’s assessments are in agreement For example, management might have pertinent information that would lead one to conclude the likely outcome of a contingency is reasonably possible or even probable Management might withhold this information from both the attorney and the auditor In that case, the auditor may not obtain a reliable assessment of the likely outcome of a contingency from the outside attorney [4] In preparation for tomorrow’s meeting with the partner and likely subsequent meeting with Murchison management, develop recommended responses to the following possible scenarios In developing your responses, assume that each scenario is independent of the others: [a] If generally accepted accounting principles require disclosure of this contingency, how would you respond to management’s decision against disclosure because they view the claim as immaterial to the December 31, 2008 financial statements? Do you believe the potential loss is material? Why or why not? The auditor would most likely note that it would be in management’s best interest to provide disclosure about the contingency, since most users would view the claim as material to the financial statements The auditor could argue that, while omitting such disclosure may have desired short term benefits, the potential harm to the company and management would be greater should the ultimate outcome of the contingency be consistent with legal counsel’s estimates Such harm could involve additional legal action against the company and management from the venture capitalists and bankers Given that the known users of the financial statements include venture capitalists and bankers who are likely to be closely monitoring pretax income, most users would likely argue that the attorney’s assessment of the range of potential loss is material While professional standards not provide guidance for estimating financial statement materiality, practitioners often use a range of to 10 percent of pretax income to estimate materiality for a for-profit business that is accountable to venture capitalists and creditors Given that pretax income for the current year is $1.8 million, a reasonable estimate of materiality would range from $90,000 to $180,000 Because the attorney’s estimated potential loss range of $150,000 to $200,000 extends beyond the high end of the auditor’s materiality estimate, most would argue that the loss contingency is material to the current year financial statements 398 Instructor Resource Manual — Do Not Copy or Redistribute To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Case 12.5: Murchison Technologies, Inc [b] Assume that even though you convince management that the claim is material, they refuse to provide any disclosure that might be required Prepare a draft of the auditor’s report that would be issued in that scenario In this scenario, management is choosing to omit a required material footnote disclosure, which clearly violates generally accepted accounting principles In this case, both the auditor and management agree that the likelihood is reasonably possible and material Because the assessment of the outcome falls in the range of reasonably possible, no accounting entry is required Therefore information presented on the balance sheet and income statement is fairly stated Only the required footnote is inappropriately excluded In those circumstances, AU Section 508 would require that the auditor issue a qualified audit opinion due to a departure from generally accepted accounting principles [Note: given that Murchison is privately-held, the auditor would report in accordance with Auditing Standards (AU) Section 508 If, however, Murchison was a public company, the scope paragraph in the auditor’s report would refer to PCAOB standards in accordance with PCAOB Auditing Standard No 1, “References in Auditors’ Reports to the Standards of the Public Company Accounting Oversight Board.”] An example of the auditor’s report in this circumstance is provided below: Custer & Custer, LLP Report of Independent Auditor To the Board of Directors and Stockholders of Murchison Technologies, Inc We have audited the accompanying balance sheets of Murchison Technologies, Inc as of December 31, 2008 and 2007, and the related statements of income, retained earnings, and cash flows for the years then ended These financial statements are the responsibility of the Company’s management Our responsibility is to express an opinion on these financial statements based on our audits We conducted our audits in accordance with auditing standards generally accepted in the United States of America Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation We believe that our audits provide a reasonable basis for our opinion The Company’s financial statements not disclose the litigation suit filed on October 16, 2008 against Murchison Technologies, Inc., for alleged copyright infringement related to the MEDTECH Software The plaintiffs seek damages of $220,000 In our opinion, disclosure of this information is required by generally accepted accounting principles In our opinion, except for the omission of the information discussed in the preceding paragraph, the financial statements referred to above present fairly in all material respects, the financial position of Murchison Technologies, Inc., as of December 31, 2008 and 2007 and the results of operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America Custer & Custer, LLP February 17, 2009 Instructor Resource Manual — Do Not Copy or Redistribute 399 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Section 12: Completing the Audit, Reporting to Management, and External Reporting [c] Assume that you determine, through subsequent discussions with the attorney, that a more likely estimate of the range of loss falls between $30,000 to $45,000 What type of financial statement disclosure you believe is required in that case? Prepare a draft of the auditor’s report that you would issue in that scenario In this scenario, both management and the auditor would likely conclude that the uncertainty is immaterial to the financial statements of Murchison Technologies The range of loss of $30,000 to $45,000 falls below the conservative rule of thumb materiality estimate described in the solution to question 4.a In this situation, no footnote disclosure would be required given the lack of materiality Assuming there are no other material adjusting entries, the auditor would issue the following standard, unqualified report: Custer & Custer, LLP Report of Independent Auditor To the Board of Directors and Stockholders of Murchison Technologies, Inc We have audited the accompanying balance sheets of Murchison Technologies, Inc as of December 31, 2008 and 2007, and the related statements of income, retained earnings, and cash flows for the years then ended These financial statements are the responsibility of the Company’s management Our responsibility is to express an opinion on these financial statements based on our audits We conducted our audits in accordance with auditing standards generally accepted in the United States of America Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation We believe that our audits provide a reasonable basis for our opinion In our opinion, the financial statements referred to above present fairly in all material respects, the financial position of Murchison Technologies, Inc., as of December 31, 2008 and 2007 and the results of operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America Custer & Custer, LLP February 17, 2009 [d] What if you learn that management has pertinent information available about the case (and the case is deemed material) but refuses to share that information with you? Prepare a draft of the auditor’s report that you would issue in that scenario In this scenario, management is restricting the auditor from examining pertinent information related to a material uncertainty Since this represents a client-imposed scope limitation, the auditor would likely issue a disclaimer of opinion An example of a disclaimer report follows: 400 Instructor Resource Manual — Do Not Copy or Redistribute To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Case 12.5: Murchison Technologies, Inc Custer & Custer, LLP Report of Independent Auditor To the Board of Directors and Stockholders of Murchison Technologies, Inc We were engaged to audit the accompanying balance sheets of Murchison Technologies, Inc as of December 31, 2008 and 2007, and the related statements of income, retained earnings, and cash flows for the years then ended These financial statements are the responsibility of the Company’s management The Company did not make available documents and other information related to a litigation suit filed on October 16, 2008 against Murchison Technologies, Inc., for alleged copyright infringement related to the MEDTECH Software The plaintiffs seek damages of $220,000 Further, other evidence related to the litigation is not available and we are unable to perform other auditing procedures related to this case Since the Company did not make available documents and other information and we were not able to apply other auditing procedures to satisfy ourselves as to the outstanding litigation claim against Murchison Technologies, Inc., the scope of our work was not sufficient to enable us to express, and we not express, an opinion on those financial statements Custer & Custer, LLP February 17, 2009 [e] Assume that you convinced management to disclose the contingency in the footnotes to the December 31, 2008 financial statements and that your audit report on those financial statements was a standard, unqualified audit report What would your responsibilities be if you learned two months after the issuance of the report that Murchison settled the case for $190,000? In this scenario, management properly complied with generally accepted accounting principles by including a footnote disclosure in the December 31, 2008 financial statements At completion of the audit (i.e., the auditor’s report date), all available information indicated that the likelihood of a material negative outcome was deemed to be reasonably possible, which required footnote disclosure Given that the financial statements included the disclosure, the auditor’s issuance of a standard, unqualified opinion report was correct The subsequent settlement of the litigation case for $190,000 does not impact the auditor’s issuance of the standard, unqualified report The settlement represents a subsequent discovery of fact that occurred after the issuance of the auditor’s report Thus, the previously issued financial statements were fairly presented at the time the audit tests were completed No further auditor action would be required Instructor Resource Manual — Do Not Copy or Redistribute 401 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Section 12: Completing the Audit, Reporting to Management, and External Reporting [f] Assume that the settlement of the litigation prohibits future sales of MEDTECH software What implication would that have on the auditor’s report on the December 31, 2008 financial statements? Given that Murchison’s sole product for generating revenues is the MEDTECH Software, a litigation settlement that prohibits future sales of that software would likely cause the auditor to have substantial doubt about Murchison’s ability to continue as a going concern If the auditor continues to have substantial doubt about the entity’s ability to continue as a going concern after considering management’s plan to address its problems, the auditor would add an explanatory paragraph to the auditor’s report Here is an example of that type of report, which assumes that the related footnote disclosure is provided: Custer & Custer, LLP Report of Independent Auditor To the Board of Directors and Stockholders of Murchison Technologies, Inc We have audited the accompanying balance sheets of Murchison Technologies, Inc as of December 31, 2008 and 2007, and the related statements of income, retained earnings, and cash flows for the years then ended These financial statements are the responsibility of the Company’s management Our responsibility is to express an opinion on these financial statements based on our audits We conducted our audits in accordance with auditing standards generally accepted in the United States of America Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation We believe that our audits provide a reasonable basis for our opinion In our opinion, the financial statements referred to above present fairly in all material respects, the financial position of Murchison Technologies, Inc., as of December 31, 2008 and 2007 and the results of operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America The accompanying financial statements have been prepared assuming that Murchison Technologies, Inc., will continue as a going concern As discussed in Note X to the financial statements, Murchison recently settled outstanding litigation associated with the alleged copyright infringement related to its MEDTECH Software That settlement prohibits Murchison from any future sales of the MEDTECH Software product That settlement arrangement raises substantial doubt about the company’s ability to continue as a going concern Management’s plans in regard to this matter are also described in Note X The financial statements not include any adjustments that might arise from the outcome of this uncertainty Custer & Custer, LLP February 17, 2009 402 Instructor Resource Manual — Do Not Copy or Redistribute To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Case 12.5: Murchison Technologies, Inc [5] Discuss why the attorney’s letter is being received so close to the completion of the audit Was the request for the attorney’s response an oversight that should have been taken care of closer to December 31, 2008, or was Custer & Custer appropriate in not requesting the response until close to the end of the audit? Auditors typically time the receipt of the attorney’s response to closely coincide with the day the auditor has completed the collection and evaluation of sufficient, appropriate audit evidence Given that the ultimate outcome of a loss contingency is dependent on the outcome of a future event, auditors prefer to wait until the audit is almost complete so that the attorney has the opportunity to consider the most recent developments in the case when preparing the attorney’s response to the auditor Therefore, the request for the attorney’s response was not an oversight on the part of the auditors, Custer & Custer Rather, the auditors purposefully timed the request from the attorney so that the related response would be received as close to the completion of the audit as is practical in the circumstances [6] Assume that Custer & Custer was delayed a month in completing the collection of audit evidence What actions would be appropriate relating to gathering evidence about potential contingencies? Given the information contained in the solution to question 5, the auditor should consider requesting the outside attorney to update in writing the attorney’s earlier response This would be particularly appropriate if events related to the case have occurred, such as depositions taken, offers of proposed settlements received, or the trial has started In some cases, the auditor may conclude that a discussion about the case with the outside attorney may be sufficient Paragraph 10 of AU Section 337 notes that in special circumstances, the auditor may obtain a response concerning matters covered by the attorney’s response letter in a conference, which offers a more detailed discussion and explanation than a written reply That paragraph notes that the auditor should appropriately document conclusions reached concerning the accounting for a loss contingency In addition to performing follow up procedures with the outside attorney, the auditor would also update all subsequent events procedures through the new date That would include, among other procedures, updating inquiries with management and reviewing recent board of directors’ minutes for issues related to the financial statements under audit, including issues related to loss contingencies The letter of representation obtained from management should be dated as of the new audit completion date [7] Review the ABA policy statement excerpts in Exhibit What limitations exist as it relates to the attorney’s response? To what extent should auditors rely solely on attorney responses to identify outstanding claims against audit clients? The ABA policy notes the attorney’s response contains these limitations: a The response is limited to matters which have been given substantive attention by the lawyer in the form of legal consultation and, where appropriate, involves legal representation since the beginning of the period or periods being reported upon b The attorney’s response only addresses legal services performed by the attorney’s firm since the beginning of the fiscal period under audit related to overtly threatened or pending litigation, whether or not specified by the client The attorney’s firm has not performed a review of the client’s transactions or other matters for the purpose of identifying other loss contingencies Paragraph 02 of AU Section 337 notes that management is responsible for adopting policies and procedures to identify, evaluate, and account for litigation, claims, and assessments as a basis for the preparation of financial statements in accordance with generally accepted accounting principles Paragraph 07 of AU Section 337 notes that the auditor normally Instructor Resource Manual — Do Not Copy or Redistribute 403 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Section 12: Completing the Audit, Reporting to Management, and External Reporting performs the following procedures in addition to obtaining the attorney’s response letter: Reading minutes of meetings of stockholders, directors, and appropriate committees held during and subsequent to the period being audited b Reading contracts, loan agreements, leases, and correspondence from taxing or other governmental agencies, and similar documents c Obtaining information concerning guarantees from bank confirmations d Inspecting other documents for possible guarantees by the client Paragraph 08 of AU Section 337 also notes that a letter of audit inquiry to the client’s attorney is the auditor’s primary means of obtaining corroboration of the information furnished by management a 404 Instructor Resource Manual — Do Not Copy or Redistribute ... this casebook is to give students hands-on exposure to realistic auditing situations focusing specifically on each aspect of the audit process The casebook contains a collection of 44 auditing cases... corrections or suggestions to: auditingcases@byu.edu Instructor Resource Manual — Do Not Copy or Redistribute ix f o u r t h e d i t i o n update s to prior c a se s Cases from the prior edition... Inc The New Client Acceptance Decision Instructor Resource Manual — Do Not Copy or Redistribute Instructor Resource Manual — Do Not Copy or Redistribute Ocean Manufacturing,