Soution manual for auditing cases 9th international edition by knapp

Soution Manual for Auditing Cases 9th International Edition by Kna Full file at https://TestbankDirect.eu/ CASE 1.1 AMRE, INC Synopsis During the mid-1980s, AMRE, Inc., was a rapidly growing company in the competitive home siding industry In 1987, the company went public and immediately began to fall short of optimistic revenue and profit projections made by its executives To prevent the company’s stock price from declining, AMRE’s executives began misrepresenting the company’s operating results and financial condition in its periodic financial statements Among the principal means used by the executives to distort AMRE’s financial status was overstating deferred advertising costs and inflating inventory AMRE’s executives convinced the firm’s independent auditors to bypass EDP tests that might have uncovered the overstatement of deferred advertising costs and also persuaded the auditors to limit their inventory observation procedures In March 1989, AMRE hired Mac Martirossian, a former manager with their audit firm, to serve as the company’s chief accounting officer Shortly after hiring Martirossian, AMRE’s executives revealed their fraudulent scheme to him Martirossian insisted that AMRE’s accounting records be immediately corrected The executives involved in the fraud acquiesced to his demands but refused to publicly disclose their fraudulent scheme by issuing corrected financial statements for the affected years Instead, the errors were largely eliminated through the preparation of year-end adjusting entries When AMRE’s auditors questioned these adjustments, Martirossian’s superiors provided false explanations for the adjustments in the presence of Martirossian, who remained silent Martirossian was uncomfortable with misleading the auditors and eventually arranged a secret meeting with them During this meeting, Martirossian subtly hinted that AMRE’s accounting records had been manipulated However, the auditors failed to grasp what Martirossian was attempting to communicate to them and thus failed to learn the true nature of the large period-ending adjustments In 1990, the SEC began an investigation of AMRE’s financial statements for the previous few years Ultimately, each of the executives who participated in the fraud was sanctioned by the SEC The SEC was especially critical of Martirossian for his “silent” role in the fraud The SEC also sanctioned the audit partner and audit manager who had been assigned to the AMRE engagements for failing to comply with generally accepted auditing standards © 2013 Cengage Learning All Rights Reserved This edition is intended for use outside of the U.S only, with content that may be different from the U.S Edition May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part Full file at https://TestbankDirect.eu/ Soution Manual for Auditing Cases 9th International Edition by Kna Full file at https://TestbankDirect.eu/ Case 1.1 AMRE, Inc AMRE, Inc. Key Facts AMRE, Inc., was a rapidly growing company in a very competitive industry AMRE routinely capitalized advertising expenditures related to "unset leads." After going public in 1987, AMRE's financial results fell short of earlier projections, which prompted company executives to begin inflating AMRE's earnings AMRE executives persuaded their auditors, Price Waterhouse, to eliminate selected audit tests and to reduce the scope of other tests In the spring of 1989, AMRE’s top executives revealed their fraudulent scheme to the company’s new chief accounting officer, Mac Martirossian, a former Price Waterhouse manager Near the end of fiscal 1989, AMRE’s executives decided to correct the company’s accounting records, principally with several large adjustments during the fourth quarter of that year During Price Waterhouse’s 1989 AMRE audit, Martirossian met secretly with the auditors and suggested to them that the large fourth-quarter adjustments did not pass the "smell test." The Price Waterhouse auditors failed to grasp what Martirossian was suggesting and thus did not discover the true nature of the fourth-quarter adjustments Martirossian and other AMRE executives signed a letter of representations indicating that they were not aware of any irregularities in the company’s 1989 financial statements 10 The SEC ruled that the audit engagement partner and the senior audit manager who oversaw the annual AMRE audits had failed to comply with GAAS during the 1988 and 1989 engagements © 2013 Cengage Learning All Rights Reserved This edition is intended for use outside of the U.S only, with content that may be different from the U.S Edition May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part Full file at https://TestbankDirect.eu/ Soution Manual for Auditing Cases 9th International Edition by Kna Full file at https://TestbankDirect.eu/ Case 1.1 AMRE, Inc Instructional Objectives To stress the importance of auditors maintaining a high degree of skepticism when dealing with client executives who have strong incentives to manipulate their company's financial statements To emphasize the hazards of allowing a client to influence key audit planning decisions To illustrate the potential for abuse of the percentage-of-completion accounting method To illustrate the critical importance of auditors remaining strictly independent of their clients To demonstrate the need for auditors to test a client's EDP controls and to consider the resulting implications for year-end substantive audit procedures To demonstrate the SEC’s willingness to impose sanctions on private accountants for failing to satisfy their ethical and professional responsibilities To examine the auditor’s responsibility for quarterly financial data included in a client’s audited financial statements Suggestions for Use This case could be assigned during coverage of the AICPA’s Code of Professional Conduct One of the most important aspects of this case, in my view, is Martirossian’s role in the cover up of the fraud This case clearly demonstrates that even an individual with integrity may not respond appropriately to an ethical dilemma I believe that it is important for instructors to point out to students that they may face these types of situations during their careers and, consequently, should have a strategy for coping with such scenarios Since a major focus of this case is management fraud, the case could be assigned during classroom discussion of auditors’ responsibilities for uncovering fraudulent misrepresentations In addition, this is another case that could be used during the first week of an auditing course to acquaint students with the nature of the independent audit function and the problematic circumstances that auditors often encounter This case is also well suited for discussion during classroom coverage of audit evidence Key features of this case include Price Waterhouse’s failure to obtain sufficient competent evidence to corroborate AMRE’s deferred advertising costs and the weak evidence collected to support the large write-offs recorded by AMRE during fiscal 1989 © 2013 Cengage Learning All Rights Reserved This edition is intended for use outside of the U.S only, with content that may be different from the U.S Edition May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part Full file at https://TestbankDirect.eu/ Soution Manual for Auditing Cases 9th International Edition by Kna Full file at https://TestbankDirect.eu/ Case 1.1 AMRE, Inc Suggested Solutions to Case Questions Generally, ethics refer to moral principles and values Random House Webster’s College Dictionary notes that ethics are “the rules of conduct recognized in respect to a particular class of human actions or governing a particular group, culture, etc.” An individual's ethics generally define what that individual believes to be right and wrong Professional ethics are typically expressed by a code of conduct adopted by an organization that represents a profession Professions adopt such codes to encourage moral conduct among their members Following is a list of the individuals involved in the AMRE case: Robert Levin, Chief Operating Officer Dennie Brown, Chief Accounting Officer Walter Richardson, Vice President of Data Processing Steven Bedowitz, Chief Executive Officer Mac Martirossian, Chief Financial Officer Edward Smith, audit engagement partner Joel Reed, senior audit manager My experience has been that students differ markedly in their assessments of the ethics of these individuals In particular, students generally have difficulty arriving at a consensus assessment of Martirossian’s conduct in this case I believe that the lively debate typically produced by this exercise is healthy for students since such debates allow them to begin developing or "fleshing out" their attitudes regarding important ethical issues and concepts The executives involved in the AMRE fraud agreed in a consent order to refrain from violating federal securities laws in the future In addition, Robert Levin and Dennie Brown forfeited funds they realized from sales of AMRE stock during the fraud Levin also paid $1.8 million to the federal government, including a $500,000 fine for insider trading Finally, Levin and Steven Bedowitz contributed approximately $9 million to a settlement pool to resolve a large class-action lawsuit Most students conclude that the AMRE executives who participated in the fraud were appropriately punished Their actions were motivated by greed and self-interest and they paid a heavy price for their indiscretions The two auditors involved in this case, Edward Smith and Joel Reed, were prohibited from being assigned to audits of SEC registrants for nine months Again, students typically find that this punishment was appropriate given the apparent mistakes made during the AMRE audits These mistakes included failing to adequately test the computerized lead bank, allowing AMRE personnel to observe certain inventory sites, accepting client explanations without applying sufficient audit procedures, and failing to require the client to disclose large and suspicious period-ending accounting © 2013 Cengage Learning All Rights Reserved This edition is intended for use outside of the U.S only, with content that may be different from the U.S Edition May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part Full file at https://TestbankDirect.eu/ Soution Manual for Auditing Cases 9th International Edition by Kna Full file at https://TestbankDirect.eu/ Case 1.1 AMRE, Inc adjustments in the financial statements The SEC issued a separate enforcement release criticizing Martirossian for his failure to take appropriate measures upon learning about the fraud Students frequently disagree with the SEC’s criticism of Martirossian Many of them view him as an ethical person who just happened to be in the wrong place at the wrong time It is important to point out to students that it is not unusual for accountants to find themselves in these types of ethical dilemmas Martirossian’s experience provides an excellent example of the potential consequences an accountant may face if he or she violates the Code of Professional Conduct Among the alternative courses of action available to Martirossian were the following: a b c d e Aid in the cover up of the fraud Demand that the executives involved disclose the fraud to the auditors If they refused to comply, report the fraud to the SEC Report the fraud to the auditors and to the Board of Directors immediately Secretly report the fraud to the auditors Resign his position with AMRE, Inc Probably the best course of action for Martirossian would have been to demand that the executives disclose the fraud to the auditors If they refused, Martirossian should have considered disclosing the fraud directly to the SEC This action would have resulted in Martirossian upholding his professional responsibilities as a CPA Although he may have lost his job, he would have avoided being sanctioned by the SEC Most important, this course of action would have prevented innocent parties, such as potential AMRE investors and creditors, from being harmed by the fraudulent scheme The relevant accounting concept in this context was the matching principle The matching principle requires that expenses be matched with the revenues they produce A cost can be deferred-treated as an asset when it is expected that the cost will produce future economic benefits (generally, revenue) It seems reasonable that a portion of AMRE’s advertising costs benefited future periods and, thus, could be appropriately deferred Nevertheless, AMRE’s policy of deferring all of the advertising costs related to unset leads was very aggressive and probably resulted in the booking of assets that would provide no future benefits for the company Listed next are key audit risk factors that were present during the 1988 and 1989 AMRE audits a b c AMRE's management had a strong incentive and desire to maintain the company's stock price at a high level AMRE’s unset leads increased dramatically during 1988 The company’s inventory also increased significantly during 1988 and increased much more rapidly than the company’s sales © 2013 Cengage Learning All Rights Reserved This edition is intended for use outside of the U.S only, with content that may be different from the U.S Edition May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part Full file at https://TestbankDirect.eu/ Soution Manual for Auditing Cases 9th International Edition by Kna Full file at https://TestbankDirect.eu/ Case 1.1 AMRE, Inc d e f g The efforts of AMRE’s executives to influence important audit planning decisions should have been of concern to the auditors The percentage-of-completion accounting method was an unusual method to apply to AMRE’s installation jobs since those jobs typically required only four to ten days to complete AMRE had several large and unusual fourth-quarter adjusting entries in 1989 Martirossian’s secret meeting with the AMRE auditors should have caused them to question the integrity of the client’s financial statements When taken together, these items suggest that the overall audit risk for the AMRE audits was relatively high Most of these risk factors were discovered by Price Waterhouse or were apparent to the audit firm For example, the audit planning memo for the 1988 audit identified the large increase in inventory as a key risk factor and called for an increase in the number of inventory observation sites Likewise, the AMRE audit partner originally requested that the company disclose the large period-ending adjustments in its 1989 10-K Although the auditors identified these risk factors, it appears that they failed to adequately consider them during the performance of fieldwork For example, company executives convinced the auditors to allow client personnel to observe several of the inventory sites selected for observation at the end of 1988 During the 1989 audit, client management persuaded the auditors not to require disclosure of the large fourth-quarter adjustments in AMREs financial statements Why did the auditors apparently defer to AMRE’s executives in several situations and fail to adequately question their decisions in others? Possibly, the auditors simply succumbed to client pressure in each of these instances During the 1989 audit, the auditors may have relied too their detriment on Martirossian, a former colleague, to inform them of any major problems in AMRE’s financial statements Whether Price Waterhouse was justified during the 1988 audit in agreeing to allow client personnel to observe the physical counts at certain inventory sites is a matter of professional judgment Apparently, members of the audit team did not believe that the client’s request posed a major problem that is, did not result in a material scope limitation, otherwise they would not have agreed to it Client management should not be allowed to influence key audit decisions such as sample size determinations, assignments of auditors to given areas of the audit, and the types of audit tests applied to specific accounts Generally, any time a client request would prevent an auditor from satisfying the requirements of the third standard of fieldwork obtaining sufficient competent evidential matter to support his or her audit opinion, that request should be denied Note: the relevant U.S auditing standards presently for audits of public companies are those issued/endorsed by the Public Company Accounting Oversight Board (PCAOB) Although SAS No 31 has been superseded by a new standard issued by the Auditing Standards Board, the PCAOB still endorses the regime of management assertions included in that standard In particular, the SAS No © 2013 Cengage Learning All Rights Reserved This edition is intended for use outside of the U.S only, with content that may be different from the U.S Edition May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part Full file at https://TestbankDirect.eu/ Soution Manual for Auditing Cases 9th International Edition by Kna Full file at https://TestbankDirect.eu/ Case 1.1 AMRE, Inc 31 list of management assertions is now embedded in Auditing Standard No 15 issued by the PCAOB In most situations, the key management assertion for an expense item is the completeness assertion That is, auditors are generally concerned that a client may attempt to understate expenses However, in this case the fourth-quarter write-offs in 1989 were initiated by AMRE management When management voluntarily recognizes a large and unusual expense item, an auditor may want to consider the possible motives underlying management’s decision Certainly, an auditor in such a case will want to investigate the completeness assertion, but the existence/occurrence assertion should also be examined by the auditor in such circumstances In recent years, many large firms have taken “big bath” write-offs to improve their chances of returning to a profitable or more profitable position in the near future In fact, the management assertion of most concern to Price Waterhouse regarding the 1989 fourth-quarter write-offs may have been the “presentation and disclosure” assertion This assertion addresses whether particular components of the financial statements “are properly classified, described, and disclosed” (AS No 15, paragraph 11) The large year-end adjustments that resulted in AMRE reporting a net loss for 1989 were clearly not adequately described in the company’s financial statements Listed next are the key responsibilities an auditor assumes for quarterly financial information included in the footnotes to a client's audited financial statements Refer to AU Section 722 for a more detailed discussion of these responsibilities a b c The auditor should apply “review” procedures to the interim financial information (Such procedures consist principally of inquiries of client personnel and analytical procedures.) The auditor should ensure that the quarterly data are presented as supplementary information and that each page of the data is clearly marked as unaudited If the results of the review procedures are satisfactory, the auditor does not need to modify his or her report on the audited financial statements to make reference to the review of the interim financial information However, if the interim financial information does not appear to be in conformity with generally accepted accounting principles, including adequate disclosure, the auditor’s report should generally be expanded to address this issue [Note: See AU 722.50b for an exception to the latter general requirement.] © 2013 Cengage Learning All Rights Reserved This edition is intended for use outside of the U.S only, with content that may be different from the U.S Edition May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part Full file at https://TestbankDirect.eu/ ... https://TestbankDirect.eu/ Soution Manual for Auditing Cases 9th International Edition by Kna Full file at https://TestbankDirect.eu/ Case 1.1 AMRE, Inc d e f g The efforts of AMRE’s executives... https://TestbankDirect.eu/ Soution Manual for Auditing Cases 9th International Edition by Kna Full file at https://TestbankDirect.eu/ Case 1.1 AMRE, Inc 31 list of management assertions is now embedded in Auditing. .. website, in whole or in part Full file at https://TestbankDirect.eu/ Soution Manual for Auditing Cases 9th International Edition by Kna Full file at https://TestbankDirect.eu/ Case 1.1 AMRE, Inc