Contemporary Auditing 8th edition Michael C. Knapp - Solutions

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Orange Grove Farms has approached your CPA firm with some questions. Orange Grove’s management has spoken with a bank about obtaining a loan to expand its operations. The bank has informed Orange Grove that the bank will not make the requested loan unless the company submits financial statements.
Your client, Cheaney Rental Properties, has engaged you to perform a compilation of its forecasted financial statements for a loan with the National Bank of Rockwood. Required: a. Describe the steps an accountant should complete when conducting a compilation of prospective financial statements.
You are the manager of the examination engagement of the financial projection of Honey’s Health Foods as of December 31, 2013, and for the year then ended. The audit senior, Currie, has prepared the following draft of the examination report: To the Board of Directors of Honey’s Health Foods: We
The following report was drafted on October 25, 2013, by Major, CPA, at the completion of an engagement to compile the financial statements of Ajax Company for the year ended September 30, 2013. Ajax is a non- public entity in which Major’s child has a material direct financial interest. Ajax
This question consists of 13 items pertaining to possible deficiencies in an accountant’s review report. Select the best answer for each item. Indicate your answers in the space provided. Jordan & Stone, CPAs, audited the financial statements of Tech Company, a non- public entity, for the year
Rhett Corporation, a local sporting goods company, has asked your firm for assistance in setting up its website. Eric Rhett, the CEO, is concerned that potential customers will be reluctant to place orders over the Internet to a relatively unknown entity. He recently heard about companies finding
Beachwood Sparks Company, a non- public company that supplies apparel to retail stores, recently has implemented a new information system. How-ever, during system development and implementation, the company experienced a great deal of turnover in personnel involved with designing and implementing
Mr. and Mrs. Greg Jun called your firm, Hillison & Reimer, in response to a brochure they received from Greg’s elderly mother. The Juns reside in Ann Arbor, Michigan, while Greg’s mother has retired to Tallahassee, Florida. In recent months, the Juns have become very concerned about
Novelis, Incorporated is the worldâ€™s leading rolledaluminum products producer. Items 1. through 3. below provide descriptions of issues involving asset impairments derived from the companyâ€™s footnote disclosures.1. In connection with the decision to close and sell our plant in
Based on the following description, determine appropriate tests of controls for the company’s controls over tangible long-lived assets.A corporation operates a highly automated flexible manufacturing facility. The capital-intensive nature of the corporation’s operations makes internal control
Match the following assertions with their associated description:(a) Existence or occurrence, (b) Completeness, (c) Rights and obligations, (d) Valuation or allocation, (e) Presentation and disclosure.1. The recorded balances reflect the true underlying economic value of those liabilities.2.
List at least five reasons that inventory is a complex accounting and auditing area.
What steps should an auditor take to help identify fraud risk factors?
For this case, use the same facts as presented in the previous problem. In Problem 9-75, we focused on the inappropriate actions of Robert A. Putnam, the engagement partner on the HBOC audit. In this case, we expand on the problems detected in the audit and ultimately ask that you decide on an
On what types of engagements must CPAs be “independent”? Identify types of engagements on which CPAs are not required to be independent. What other traits should CPAs possess on professional services engagements?
The Enron debacle created what one public official reported was a “crisis of confidence” on the part of the public in the accounting profession. List the parties who you believe were most responsible for that crisis. Briefly justify each of your choices.
List three types of consulting services that audit firms are now prohibited from providing to clients that are public companies. For each item, indicate the specific threats, if any, that the provision of the given service could pose for an audit firm’s independence.
For purposes of this question, assume that the excerpts from the Powers Report shown in Exhibit 3 provide accurate descriptions of Andersen’s involvement in Enron’s accounting and financial reporting decisions. Given this assumption, do you believe that Andersen’s involvement in those
Briefly describe the key requirements included in professional auditing standards regarding the preparation and retention of audit work-papers. Which party “owns” audit work-papers: the client or the audit firm?
Identify five recommendations made to strengthen the independent audit function following the Enron scandal. For each of these recommendations, indicate why you support or do not support the given measure. Also indicate which of these recommendations were eventually implemented.
Do you believe that there has been a significant shift or evolution over the past several decades in the concept of “professionalism” as it relates to the public accounting discipline? If so, explain how you believe that concept has changed or evolved over that time frame and identify the key
As pointed out in this case, the SEC does not require public companies to have their quarterly financial statements audited. What responsibilities, if any, do audit firms have with regard to the quarterly financial statements of their clients? In your opinion, should quarterly financial
When Lehman was developing its Repo 105 accounting policy, did E&Y have a responsibility to be involved in that process? In general, what role should an audit firm have when a client develops an important new accounting policy? Comment on an audit firm’s responsibilities during and following that
Do you agree with the assertion that “intent doesn’t matter” when applying accounting rules? That is, should reporting entities be allowed to apply accounting rules or approved exceptions to accounting rules for the express purpose of intentionally embellishing their financial statements or
Do auditors have a responsibility to determine whether important transactions of a client are “accounting-motivated”? Defend your answer.
William Schlich implied that E&Y’s British affiliate had the responsibility for reviewing the legal opinion issued by a British law firm regarding the treatment of Repo 105s as sales of securities. Do you believe that Schlich or one of his subordinates should have reviewed that letter? Why or why
Lehman’s net leverage ratio was not reported within the company’s audited financial statements but rather in the company’s financial highlights table and MD&A section of its annual report. What responsibility, if any, do auditors have to assess the material accuracy of financial data
The Repo 105 transactions reduced Lehman’s net leverage ratio from 17.8 to 16.1 at the end of fiscal 2007. Do you believe that was a “material difference”? Why or why not?
In general, what responsibility do auditors have to investigate whistleblower allegations that relate to the material accuracy of an audit client’s financial statements?
E&Y is a defendant in Lehman-related lawsuits filed in both state and federal courts. Identify the factors that influence E&Y’s legal exposure between lawsuits filed in state courts versus those filed in federal courts.
Prepare common-sized balance sheets and income statements for Just for Feet for the period 1996–1998. Also compute key liquidity, solvency, activity, and profitability ratios for 1997 and 1998. Given these data, comment on what you believe were the high-risk financial statement items for the 1998
Just for Feet operated large, high-volume retail stores. Identify internal control risks common to such businesses. How should these risks affect the audit planning decisions for such a client?
Just for Feet operated in an extremely competitive industry, or sub industry. Identify inherent risk factors common to businesses facing such competitive conditions. How should these risks affect the audit planning decisions for such a client?
Prepare a comprehensive list, in a bullet format, of the audit risk factors present for the 1998 Just for Feet audit. Identify the five audit risk factors that you believe were most critical to the successful completion of that audit. Rank these risk factors from least two most important and be
Put yourself in the position of Thomas Shine in this case. How would you have responded when Don-Allen Ruttenberg asked you to send a false confirmation to Deloitte & Touche? Before responding, identify the parties who will be affected by your decision.
BDO Seidman’s attorneys pointed out correctly that professional standards do not prohibit auditors and client personnel from being “friends.” At what point do such relationships result in violations of the auditor independence rules and guidelines? Provide hypothetical examples to strengthen
According to court testimony, on 20 July 1995, Drew Bergman recommended to HMI’s board of directors that Mei-ya Tsai be hired as the company’s chief accounting officer (CAO). One week later, BDO Seidman issued its audit report on HMI’s 1995 financial statements. Under presently existing
Under what circumstances is an inventory rollback or roll-forward typically performed? How valid is the evidence yielded by this audit procedure? Explain.
Jill Karnick abandoned her attempt to complete an inventory roll-forward because of the considerable amount of work the procedure involved. Do you believe she made an appropriate decision given the circumstances she faced? How should auditors weigh the cost of an audit procedure, in terms of time
Should the results of inconclusive audit tests be included in audit work-papers? Defend your answer.
A major focus of the trial in this case was BDO Seidman’s consideration of, and response to, the “red flags” apparent during the 1995 HMI audit. Define or describe the phrase “red flags.” Explain the impact of red flags identified by auditors on each major phase of an audit.
The PSLRA requires auditors to report to the SEC illegal acts “that would have a material effect” on a client’s financial statements, assuming client management refuses to do so. Briefly describe three hypothetical situations involving potential illegal acts discovered by auditors. Indicate
Prepare common-sized financial statements for Leslie Fay for the period 1987–1991. For that same period, compute for Leslie Fay the ratios shown in Exhibit 2. Given these data, which financial statement items do you believe should have been of particular interest to BDO Seidman during that
In addition to the data shown in Exhibit 1 and Exhibit 2, what other financial information would you have obtained if you had been responsible for planning the 1991 Leslie Fayaudit?
List nonfinancial variables or factors regarding a client’s industry that auditors should consider when planning an audit. For each of these items, briefly describe their audit implications.
Paul Polishan apparently dominated Leslie Fay’s accounting and financial reporting functions and the individuals who were his subordinates. What implications do such circumstances pose for a company’s independent auditors? How should auditors take such circumstances into consideration when
Explain why the SEC ruled that BDO Seidman’s independence was jeopardized by the lawsuits that named the accounting firm, Leslie Fay, and top executives of Leslie Fay as codefendants.
Should auditors evaluate the soundness of a client’s business model? Defend your answer.
Identify and briefly describe the specific fraud risk factors present during the 2000 Next-Card audit. How should these factors have affected the planning and execution of that engagement?
What are the primary objectives an audit team hopes to accomplish by preparing a proper set of audit work-papers?
Identify the key auditing principles violated by the E&Y auditors in this case. Briefly explain how each principle was violated.
When he became a member of the Next-Card audit engagement team, Oliver Flanagan hoped that Thomas Trauger would serve as his mentor. What responsibility, if any, do senior audit personnel have to serve as mentors for their subordinates?
Assume the role of Oliver Flanagan in this case. What would you have done when Thomas Trauger asked you to help him alter the 2000 Next-Card audit work-papers? In answering this question, identify the alternative courses of action available to you. Also identify the individuals who may be affected
Arthur Young was criticized for not encouraging Lincoln to invoke the substance-over-form principle when accounting for its large real estate transactions. Briefly describe the substance-over-form concept and exactly what it requires. What responsibility, if any, do auditors have when a client
Explain how the acceptance of large, high-risk audit clients for relatively high audit fees may threaten an audit firm’s de facto and perceived independence. Under what circumstances should such prospective clients be avoided?
How is an auditor’s examination affected when a client has engaged in significant related-party transactions? What measures should an auditor take to determine that such transactions have been properly recorded by a client?
Professional standards require auditors to consider a client’s “control environment.” Define control environment. What weaknesses, if any, were evident in Lincoln’s control environment?
What was the significance of Lincoln receiving nonrecourse notes rather than recourse notes as payment or partial payment on many of the properties it sold?
Professional auditing standards identify the principal “management assertions” that underlie a set of financial statements. What were the key assertions that Arthur Young should have attempted to substantiate for the Hidden Valley transaction? What procedures should Arthur Young have used for
Do you believe that Jack Atchison’s close relationship with Lincoln and Charles Keating prior to his leaving Arthur Young was proper? Why or why not? After joining Lincoln’s parent company, ACC, should Atchison have “interfaced” with the Arthur Young auditors assigned to the Lincoln and ACC
Does the AICPA Code of Professional Conduct discuss the collegial responsibilities of CPA firms? In your opinion, were representatives of either Ernst & Young or Kenneth Leventhal & Company unprofessional in this regard during their congressional testimony?
What responsibility does an auditor have to uncover fraud perpetrated by client management? Discuss factors that mitigate this responsibility and factors that compound it. Relate this discussion to Arthur Young’s audits of Lincoln.
Compute key ratios and other financial measures for Crazy Eddie during the period 1984–1987. Identify and briefly explain the red flags in Crazy Eddie’s financial statements that suggested the firm posed a higher-than-normal level of audit risk.
Identify specific audit procedures that might have led to the detection of the following accounting irregularities perpetrated by Crazy Eddie personnel:(a) The falsification of inventory count sheets,(b) The bogus debit memos for accounts payable,(c) The recording of transshipping transactions as
The retail consumer electronics industry was undergoing rapid and dramatic changes during the 1980s. Discuss how changes in an audit client’s industry should affect audit planning decisions. Relate this discussion to Crazy Eddie.
Explain what is implied by the term low-balling in an audit context. How can this practice potentially affect the quality of independent audit services?
Assume that you were a member of the Crazy Eddie audit team in 1986. You were assigned to test the client’s year-end inventory cutoff procedures. You selected 30 purchase invoices entered in the accounting records near year-end: 15 in the few days prior to the client’s fiscal year-end and 15 in
Should companies be allowed to hire individuals who formerly served as their independent auditors? Discuss the pros and cons of this practice.
Ernst & Whinney never issued an audit opinion on financial statements of ZZZZ Best but did issue a review report on the company’s quarterly statements for the three months ended 31 July 1986. How does a review differ from an audit, particularly in terms of the level of assurance implied by the
Professional auditing standards identify the principal “management assertions” that underlie a set of financial statements. The occurrence assertion was particularly critical for ZZZZ Best’s insurance restoration contracts. ZZZZ Best’s auditors obtained third-party confirmations to support
In testimony before Congress, George Greenspan reported that one means he used to audit the insurance restoration contracts was to verify that his client actually received payment on those jobs. How can such apparently reliable evidence lead an auditor to an improper conclusion?
What is the purpose of predecessor–successor auditor communications? Which party, the predecessor or successor auditor, has the responsibility for initiating these communications? Briefly summarize the information that a successor auditor should obtain from the predecessor auditor.
Did the confidentiality agreement that Minkow required Ernst & Whinney to sign improperly limit the scope of the ZZZZ Best audit? Why or why not? Discuss general circumstances under which confidentiality concerns on the part of a client may properly affect audit planning decisions. At what point do
What procedures, if any, do professional standards require auditors to perform when reviewing—prior to the completion of the audit—a client’s post-year-end earnings press release?
Exhibits 1 and 4 present DHB€™s original 2003€“2004 balance sheets and income statements and the restated balance sheets and income statements for those two years, respectively. Review the original and restated financial statements for 2004 and identify the
Identify the fraud risk factors posed by DHB for its independent auditors. Which of these factors, in your opinion, should have been of primary concern to those auditors?
During the 2004 DHB audit, the company’s independent auditors had considerable difficulty obtaining reliable audit evidence regarding the $7 million of obsolete vest components that allegedly had been destroyed by a hurricane. What responsibility do auditors have when the client cannot provide
What responsibility, if any, do auditors have to search for related-party transactions? If auditors discover that a client has engaged in related-party transactions, what audit procedures should be applied to them?
Compare and contrast the internal control reporting responsibilities of the management and independent auditors of public companies.
What potential consequences do frequent changes in auditors have for the quality of a given entity’s independent audits? Identify professional standards or other rules and regulations that are intended to discourage auditor changes or provide disclosure of the circumstances surrounding them.
David Brooks apparently made threatening remarks to certain of his company’s independent auditors. What actions should auditors take when they are the target of hostile statements or actions by client executives or employees?
Does the SEC have a responsibility to protect the investing public from self-interested corporate executives? Do professional auditing standards or other rules or regulations impose such a responsibility on independent auditors?
The audit committee of DHB Industries was criticized for failing to carry out its oversight responsibilities. What are the primary responsibilities of a public company’s audit committee?
KPMG served as the independent audit firm of several of the largest subprime mortgage lenders. Identify the advantages and disadvantages of a heavy concentration of audit clients in one industry or sub industry.
As noted in the case, there was an almost complete turnover of the staff assigned to the New Century audit engagement team from 2004 to 2005. What quality control mechanisms should accounting firms have in such circumstances to ensure that a high-quality audit is performed?
Section 404 of the Sarbanes–Oxley Act requires auditors of a public company to analyze and report on the effectiveness of the client’s internal controls over financial reporting. Describe the responsibilities that auditors of public companies have to discover and report (a) significant
One of New Century’s most important accounts was its loan repurchase loss reserve. Each accounting period, New Century was required to estimate the ending balance of that account. What general principles or procedures should auditors follow when auditing important “accounting estimates”?
New Century’s bankruptcy examiner charged that KPMG did not comply with applicable “professional standards” while auditing the company. List specific auditing standards or principles that you believe KPMG may have violated on its New Century engagements. Briefly defend each item you list.
Mortgage-backed securities (MBS) produced by New Century and other major subprime lenders were a focal point of attention during the recent financial crisis. Many parties maintain that the mark-to-market rule for investments in securities such as MBS contributed significantly to that crisis and
Identify what you consider to be the three most important “take-aways” or learning points in this case. Rank these items in order of importance (highest to lowest). Justify or defend each of your choices.
Research recent developments involving this case. Summarize these developments in a bullet format.
In addition to the reforms mentioned in this case, recommend other financial reporting and auditing-related reforms that would likely be effective in preventing or detecting frauds similar to that perpetrated by Madoff.
Suppose that a large investment firm had approximately 10 percent of its total assets invested in funds managed by Madoff Securities. What audit procedures should the investment firm’s independent auditors has applied to those assets?
Describe the nature and purpose of a “peer review.” Would peer reviews of Friehling & Horowitz have likely resulted in the discovery of the Madoff fraud? Why or why not?
Professional auditing standards discuss the three key “conditions” that are typically present when a financial fraud occurs and identify a lengthy list of “fraud risk factors.” Briefly explain the difference between a fraud “condition” and a “fraud risk factor” and provide examples
What factors likely contributed to the oversights made by the Ernst & Young auditors during the 2004 AA Capital engagement? Identify measures that audit firms can implement to minimize the likelihood of such oversights on audit engagements.
Was it appropriate for Ernst & Young to decide not to rely on AA Capital’s internal controls during the 2004 audits? Under what circumstances can auditors choose not to rely on a client’s internal controls?
What audit procedures do professional auditing standards require that auditors apply to related party transactions? Would any of these procedures have resulted in Ernst & Young discovering the true nature of the cash transfers made to John Orecchio?
What objectives do auditors hope to accomplish in performing “subsequent period” audit tests?
Do you agree with the assertion of John Ellingsen that an audit engagement partner is not “responsible for all decisions made in the course of an engagement?” Defend your answer. What quality control implications does that assertion, if true, have for audit firms?

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Contemporary Auditing 8th edition Michael C. Knapp - Solutions

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