Allen & Watkins LLP audited the December 31, 20X5, financial statements of Giant Sports Mart. Fieldwork was completed during the month of February 20X6. The audit partner, John Watkins, CPA, reviewed and signed off on the audit working papers on February 28, 20X6. John then met with the Board of Directors on March 5, 20X6, to discuss the financial results and get them to approve the financial statements. Giant Sports Mart had an exceptional year — although the economic recession had hurt many local companies, Giant Sports Mart did not seem to be impacted. Allen & Watkins issued an unqualified opinion. The audited financial statements were distributed to investors on March 6, 20X6. It came to light in May 20X6 that a significant portion of sales recorded in 20X5 were between Giant Sports Mart and a company owned by the president’s wife. Revenues and profits were materially overstated. Allen & Watkins LLP did not identify that these fraudulent transactions were between related parties and, as a result, the financial statements did not adequately disclose the existence of the relationship. Investors viewed the positive results found in the audited financial statements as a good indicator of the company’s success at weathering the economic recession. Based on the financial results, investors provided additional capital for expansion. Required: a. What are Allen & Watkins’s responsibilities in identifying the fraudulent overstatement of revenues? (3 marks)

b. Provide two examples of pressures that contributed to the fraudulent overstatement of revenues. (2 marks)

c. What are Allen & Watkins’s responsibilities in identifying related parties? (2 marks)

d. What procedures would Allen & Watkins have performed regarding related-party transactions during the 20X5 audit? (4 marks)

e. What discussions should the audit engagement team at Allen & Watkins have had regarding fraudulent transactions involving related parties? (2 marks)

f. Evaluate whether Allen & Watkins should have identified the material misstatement. (3 marks)

g. What would have been included in the management representation letter specific to related parties? (2 marks)

h. What date would be used for the audit report date for the December 31, 20X5, year-end audit? (2 marks)

i. Assuming that Allen & Watkins found the overstatement of revenues during fieldwork and management refused to adjust the financial statements, which audit opinion should have been issued? (3 marks)

j. Discuss whether the discovery of fraudulent financial reporting is a subsequent event. (2 marks)

k. Discuss whether Allen & Watkins has a responsibility to perform additional procedures related to the discovery of the overstatement of revenues. (4 marks)

l. Assume that Giant Sports Mart’s management decides to revise the 20X5 financial statements in May 20X6. What actions should Allen & Watkins take? (6 marks)

Answer rating: 100% (QA)

a Responsibilities in Identifying Fraudulent Overstatement Allen Watkins have a responsibility to plan and perform the audit to obtain reasonable assu... View the full answer