You are retained by Columbia Corporation to audit its financial statements for the fiscal year ended June 30. Your consideration of internal control indicates a fairly satisfactory condition, although there are not enough employees to permit an extensive separation of duties. The company is one of the smaller units in its industry, but it has realized net income of about $500,000 in each of the last three years.
Near the end of your fieldwork, you overhear a telephone call received by the president of the company while you are discussing the audit with him. The telephone conversation indicates that on May 15 of the current year the Columbia Corporation made an accommodation endorsement of a 60-day $430,000 note issued by a major customer, Brill Corporation, to its bank. The purpose of the telephone call from Brill was to inform your client that the note had been paid at the maturity date. You had not been aware of the existence of the note before overhearing the telephone call.
a. From an ethical standpoint, do you think the auditors would be justified in acting on information acquired in this manner?
b. Should the balance sheet as of June 30 disclose the contingent liability? Give reasons for your answer.
c. Prepare a list of auditing procedures that might have brought the contingency to light. Explain fully the likelihood of detection of the accommodation endorsement by each procedure listed.