Week 3 Assignment

Group 2
Allison Diaz, Vincent Reilly, Jacqueline Cassano, & Steven Giardina
ACC-675
Professor Hullstrung
Introductory Case

DISCUSSION QUESTIONS

Note to students: Many of the discussion questions and exercises are open-ended, designed to
stimulate your ability to analyze auditing problems. Often, as in a real audit, there is no
absolutely correct answer. You must evaluate the facts and attempt to arrive at a logical
conclusion or a viable course of action. To guide your analysis, you may want to consult a
standard auditing textbook, the "Statements on Auditing Standards" issued by the Auditing
Standards Board, or any other relevant authoritative pronouncements produced by the AICPA
(nonpublic companies) and the PCAOB (public companies).

(1) What are the main duties of each of the positions that comprise Abernethy and
Chapman's engagement team (i.e., partner, manager, senior auditor, and staff auditor)?

The main duties of each of the positions that comprise Abernethy and Chapman’s engagement
team are:

Partner: Responsible for determining if the final reports produced by managers and the audit
team are completed to the standards of the firm and ready for signature.

Manager: Supervises Seniors and Staff. Responsible for audit program approval, personnel
scheduling, audit working papers review, financial statement disclosure footnote approval, day-
to-day client relationships, determination of billings for engagements, and training and
evaluation of Staff and Seniors.

Senior Auditor: Works under the general direction of an Audit Manager. Responsibilities include
the direction of audit field work, assignment of detail work to Staff, and review of their working
papers. Also prepares financial statements, develops corporate tax returns, and suggests
improvements to internal controls.

Staff Auditor: Performs the detail work of a financial audit under the supervision of a Senior.
(does the least risky work because has the least experience, with more experience the riskier
work you get, takes care of the more complex work) (Vincent Reilly)

(2) What is the purpose of having both a partner-in-charge and a consulting partner on
each audit engagement? Should the partners be rotated periodically? Why or why not?

The purpose of having both a partner-in-charge and a consulting partner on each audit
engagement is that the partner-in-charge makes the definitive decisions and is head of the audit
engagement. While the consulting partner advises and reviews the final work of the team.
Required by the PCAOB & Sarbanes Oxley, partners are to rotate on audits every 5 years.
Partners will lose objectivity, they will get too comfortable & won’t ask the same questions .
AICPA suggest every 5 year. (Allison Diaz)

(3) Can an accounting firm hope to accrue any real benefit from a marketing campaign
such as the one carried out by Abernethy and Chapman? Should the management of a
company select its auditors based on advertisements alone?

Like any other business, I think it is beneficial to market yourself so potential clients are aware
of your services. However, the overall decision by clients to choose your firm over another will
likely be based solely on the reputability that your firm has in the marketplace. Therefore, based
on advertising alone, I do not think management should select its auditors under this criteria.
The case that many professionals bring up regarding advertisement is that lower quality work is
provided by these companies that push their services through lower rates as a result of
competition. A reputable audit firm is more desirable than that of a firm with a strong marketing
campaign. (Vincent Reilly)

-can’t really sell an audit its mainly based on reputation

- “we are here to help your business” (p.6 in case study book) that makes it seem a lack of
independence

(4) Larger (often national or international) CPA firms have acquired many smaller firms.
Why might a large organization consider purchasing an accounting firm such as
Abernethy and Chapman? Why might Abernethy and Chapman agree to be acquired?
Are such mergers good for the auditing profession, generally speaking?

I think larger organizations consider acquiring smaller firms due to the opportunity of growth.
Everyone wants to be on the top so doing this allows for the larger firms to possibly expand their
services as the smaller firm may have provided things that they didn’t. Along with that it also
allows for access of their clients now, gaining more exposure. Abernethy and Chapman is said
to have a number of large clients in the area of Richmond. It also is a possibility they wanted to
gain access to that area as Abernethy and Chapman is located in Virginia so maybe they looked
into the data in that area and decided it would be good for their growth. I think this could also go
for Abernethy and Chapman, for their reason to be acquired. They seem to be doing well for
themselves but becoming one definitely could put them on the top. It gets hard as competition is
a big thing in the business world, also trying to provide the next best thing at the best price.
Usually bigger companies have the better opportunity to take clients from the smaller
companies. I think if there is going to be mergers, it does get tricky in the auditing profession. It
gets harder to stay independent with the clients and provide unbiased opinions. (Jacqueline
Cassano)

(5) The case stated that, during busy periods, individuals may move from one area of the
firm to another, for example from consulting services to assurance services. Are there
any potential problems with these movements within the firm?
 I definitely do see there being problems. One of the biggest things auditors have to abide to is
independence. Independence involves integrity, or being able to give a client their honest
opinion with no interference from a relationship with the client. There would be no independence
if that employee provided a company with consulting services then moved to the assurance
services for that same client as they then have formed a relationship with that client and have
already provided them with information based off their financial data. (Jacqueline Cassano)

-Moving from one area to another, that person will lack knowledge (learning curve)
- Professional standards require auditors to have competence

EXERCISE

(1) Review the quality control standards of Abernethy and Chapman, and prepare a memo to
Ms. Malott addressing the firm's policies. From the information provided, how does the firm
appear to meet or not meet each of the quality control standards? If additional information is
needed, state what information you would need to have to make the assessment. What
recommendations for improvements do you have for the firm? Be sure to consider all of the
elements of quality control as required by Standard of Quality Control Standards No. 7, A
Firm’s System of Quality Control, issued by the AICPA. The elements are (1) leadership
responsibilities, (2) relevant ethical requirements, (3) acceptance and continuation of clients, (4)
human resources, (5) engagement performance, and (6) monitoring. [See template "IntroCase-
1.doc"].
Introductory Case
Exercise 1

To: DeAnna Malott

From: Allison Diaz
Date: 9/20/19
Re: Quality Control Standards at Abernethy and Chapman

Overview: The following is a review of Abernethy and Chapman quality control standards within
the firm in accordance with the AICPA six elements.

Standard Existing Procedures Recommendations Additional Information

Needed

Leadership -Partner-in-charge of -Further explain the What are the company’s

responsibilities the audit heads firm’s policy policies and procedures?
engagement team -Tone at the Top How are policies being
- hieratical system monitored?
Relevant ethical -Employees must -doesn’t haven’t have engagement partners to
requirements sever all financial ties sever all ties (it provide relevant information
to audit clients depends on your role) about client engagements
- -what about employee’s
families and partners?
Regarding independence

Acceptance and Review each client

continuation of before accepting or
clients continuing
engagements

-employees are to sit Performance reviews

Human resources for the CPA exam
within one year of
employment
-accountants must
complete 40 hrs per
yr of continuing
education
-promotions are
guided seniority and
technical competence
- Ms. Malott’s
considers the
employee’s
experience with
client’s business and
technical training

Engagement -Firms policy requires The case doesn't Documentation of work

performance the assignment of a mention how the performed during the audit
consulting partner, as engagement is
well as partner-in- documented. The firm
charge should develop work
-The manager, senior papers to document
auditor, and staff their audit
auditors perform the
procedures required
by the audit
 Ms. Malott’s monitors The case doesn't Documentation of quality
Monitoring the quality control mention any control standards
standards documentation of
quality controls. The
firm should develop
such documentation

Conclusion: Abernethy and Chapman had some quality controls in place, but there’s room for
improvement. Abernethy and Chapman should develop a system to document work performed
during audit engagements, and quality control standards. Furthermore, while acquiring new
clients, standards should be put in place so that the company avoids any unwanted
occurrences.

THE IMPACT OF SARBANES-OXLEY

(1) The case states that the firm of Abernethy and Chapman is considering the
acceptance of clients that are publicly traded. What specific steps would the firm have to
take before they could accept an audit client that is publicly traded?

The PCAOB states the steps for audit planning. The PCAOB AS 2101 states that audit planning
starts with properly establishing a strategy for the engagement and developing an audit plan but
in particular planned risk assessment procedures and planned responses to the risks of material
misstatement. There has to be procedures regarding the continuance of the client relationship
as well as determine compliance with independence and ethic requirements. In regards to
actually planning, they must know the size and complexity of the company as well as any
previous experience with the company. I think overall it’s best to find out about the company that
you want to take on as well as evaluate their standing in the community. Also find out what had
happened with its previous auditor. There needs to be a strong sense of integrity in that
company and to see if there is any likelihood of fraud that could cost them their job. (Jacqueline
Cassano)

-first have to register with the PCAOB and pay fees

-firms with over 100 public audit clients gets inspected every year less is every other
-can’t consulting advice or tax advice to audit client because then you will be auditing your own
work. Also, can’t implement a system because you will be auditing your own work.
-Have to have an audit committee (have to have a financial expert on the audit committee)
-They hire the auditor because management hires auditors it’s not as objective
-Approves fees and work (management may ask auditor to do a task but auditor needs
approval from the audit committee before doing task
(2) Discussion question #2 above addresses audit engagement management, consulting
partners and rotation. Discuss how Sarbanes-Oxley has affected these issues.

Sarbanes-Oxley (SOX) was enacted in 2003 and set regulations on how audits and other
services must be done. This created a new standard so that the public can rely on the
information that was given to the general public before making investment decisions. These new
standards specified what makes a person and firm independent. Independence relies on many
factors but the biggest factors are investment portfolio, services performed by firm, and non-
cash compensation. The main reason these factors are taken into effect are to ensure that the
auditors have no financial interest in the client that will impair there judgement. Therefore if
independence is established the development of the audit plan and quality of the audit will not
be impaired. Another aspect that helps strengthen the independence between clients and the
audit firms is the mandatory partner rotation that was put into place by Sarbanes-Oxley. This
requires that audit and consulting partners rotate off of the audit after 5 years. The partners can
later return to the audit although there is no specified period required under SOX, the SEC
requires a period of two years before the partners may return. (Steven Giardina)

Website used:

https://www.sec.gov/rules/final/33-8183.htm
https://pcaobus.org/Standards/Archived/PreReorgStandards/Pages/Auditing_Standard_9.aspx
Analysis of Potential Audit Client

DISCUSSION QUESTIONS

(1) Why would the owners of Lakeside as well as the company's banks require that an
independent CPA firm perform an annual audit?

Lakeside, as well as the company's banks, require that an independent CPA firm performs an
annual audit because they want the auditor to be unbiased. If a CPA firm performs both audits,
then they are no longer considered independent. The reason behind wanting an independent
unbiased auditor is because users of the financial statements want to ensure these statements
are fairly present. Users of the financials use these statements to make critical decisions. For
instance, the company's bank will use Lakeside financial statements to decide whether to grant
them any future loans. (Allison Diaz)

(2) This case implies that no auditor with the firm of Abernethy and Chapman has an in-
depth understanding of the consumer electronics industry. Is a CPA firm allowed to
accept an engagement without having established the necessary expertise to oversee
the audit? Would the knowledge required to audit a consumer electronics company
differ significantly from that needed in the examination of a car dealership? Does the
auditor have an obligation to discuss his lack of expertise, or his plans to obtain the
expertise with the client?

-For a CPA firm to accept an engagement they should have some familiarity or expertise in the
client’s business so that the audit can be completed properly. -Yes, the knowledge required to
audit a consumer electronics company differ significantly from that needed in the examination of
a car dealership. The consumer electronics is a different industry from car dealership. Also,
each company has different risk areas and require different testing.
-Yes, the auditor has the obligation to discuss his lack of expertise, or his plans to obtain the
expertise with the client. The firm shouldn’t necessarily state that they don’t have knowledge
(Allison Diaz)

(3) Auditors must assess the possibility of fraud risk factors. Fraud risk factors are
events or situations that would indicate an increased possibility that fraud has occurred.
Lakeside has recently created a profit-sharing bonus plan. Why might such an incentive
be a special concern to an auditor?

This type of incentive creates risk because of the method they are calculating the bonus. This
incentive gives managers and assistant managers a reason to fraudulently raise store profits or
reallocating expenses to increase their bonus. The calculation is done on a yearly basis which
gives incentives to manager to recognize revenues early. This is all assuming that the company
doesn’t have internal controls to stop this type of activity. This might create the impression of
boosted revenues but will eventually be met with a loss in subsequent years. Therefore an
auditor would need to assess the quality of the internal controls to offset the risk of fraud.
(Steven Giardina)

(4) Rogers wants Abernethy and Chapman to assist his company in developing new
accounting systems. Does a CPA firm face an independence problem in auditing the
output of systems that the same firm designed and installed? Does your answer depend
on if the client is publicly traded or not? How so?

I think there can be an independence problem in auditing the output of systems that the same
firm designed and installed. I also think it depends on if the client is publicly traded or not. For
Abernethy and Chapman to audit Roger’s company, they would have to stay out of helping them
develop a new system if Roger’s company was public as there are a lot more standards
required to be followed within public companies. They would technically be auditing their own
work which would not allow for an unbiased opinion. (Jacqueline Cassano)

-AICPA is gray about this but the PCAOB states no. Can’t implement a system because you will
be auditing your own work. If going public have to follow PCAOB standards

(5) After the discussion at the CPA firm, Andrews was assigned to visit the
headquarters/warehouse of Lakeside to tour the facility. What should Andrews observe,
and what factors should he be especially aware of during this visit?

During the visit to the headquarters Andrews should be aware that management has prepared
for your visit. The company might not be operating as they usually do because you are there.
Therefore it is important for Andrews to make inquiries about the processes and controls in
place. Andrew should also observe the inventory and other tangible assets to gain awareness of
what assets they have. This all to get a better understanding of how the company operates and
areas of risk that might need to be addressed so they can better plan on how to audit if they
choose to accept them as a client. (Steven Giardina)

-how old is they’re inventory? Is it stored properly? Can it get easily stolen?
-examine what they say is there, is there
-asses working conditions and security

(6) Is there any reason why Lakeside might not want to hire a CPA firm that has other
clients in the electronics industry?
The main reason Lakeside might not want to hire a firm that has clients in the field is because
they might be committing some kind of fraud. Roger talked about how their sales have been low
due to the change in their products and they might be trying to raise profits fraudulently. This
can be supported by there policy to give customers that pay swiftly deep discounts. Another
concern is that they are creating a separate entity to lease their 7th building out to Lakeside
which would count as a parties in interest transaction. This can be used to offset the expenses
of the new building to another company to help raise revenues. Lastly they might be trying to
avoid making the correction for last year by getting a firm that doesn’t have expertise in this
field. These are the three reasons why Lakeside is looking for an auditor inexperienced in the
field. (Steven Giardina)

The client may believe it’s a conflict of interest even though there isn’t. it depends on the client’s
perception

EXERCISES

(1) According to Statement on Auditing Standards, Consideration of Fraud in a Financial

Statement Audit, the auditor should consider whether the information indicates that one
or more fraud risk factors are present. Fraud risk factors are potential problems or
indicators of potential fraud. Three conditions that are typically present when fraud
exists: an incentive or pressure to perpetrate fraud, an opportunity to carry out the
fraud, and the attitude to justify the fraudulent action. Based on the conference with
Rogers, perform the following [Case1-1.doc]:

a) List the fraud risk factors that the CPA firm might encounter if they accept this
audit engagement. Be sure to include a discussion of all items that will probably require
special attention during the audit. You should find at least 10 fraud risk factors.
b) For each of these fraud risk factors, indicate how the auditor should follow up
on each potential problem if the engagement is accepted. Consider how Abernethy and
Chapman should include the fraud assessment in conducting the audit.

Case 1 - Exercise 1
Abernethy and Chapman
Fraud Risk Factors

Client: Abernethy and Chapman

Prepared by: Vincent Reilly
Date: 9/23/19

Fraud Risk Factors Auditor Follow Up

Internal Controls: While attempting to brand A strong understanding of internal controls

their operations across both Virginia and is necessary by auditors in order for them to
North Carolina, problems with controls could conclude their services. To follow up, testing
arise. for weakness in controls is a vital step and
can be completed through gathering
different forms of evidence.

Inventory: A substantial audit risk for a The auditor needs to visit the locations of
business of Lakeside’s size would make the inventory and analyze each by verifying
inventory a focal point. the existence and value of the electronic
equipment along with other key factors.

Accounts Receivable: With an electronic With frequent orders to Cypress being

store like Lakeside, their distribution to carried out, making sure that the collection
Cypress on a weekly basis are made on of these receivables are properly accounted
account. for will be a focus of the auditor.

Returns: Since they allow up to 20% of The size of inventory allowance that is
merchandise to be returned within four returnable within this time period could
months. cause issues and will be a focus of the
auditor. Revenue issue- can inflate earnings

Growth: As stated, to finance their growth, Public offerings bring more readers to their
the company is considering a public offering financial statements and this pressure could
of stock. result in the falsification and manipulation of
finances in order to attract investments.

Sixth store: Since the opening in November Since a qualified opinion from the previous
2010 of the sixth store adjacent to a CPA firm was issued, making sure that the
shopping center, is very unsuccessful. issues surrounding this sixth store are
addressed and resolved in the current year
fiscal year.

Distributorship Sales: Cypress’ reputation Validating the sales in respect to the

began to spread over the past two years increased quantity being shipped out to
therefore, Lakeside’s sales to Cypress have Cypress is important for the auditor to
risen materially over this time. consider.

Distribution of Bonuses: The relatively new If the bonus system is not properly set up,
bonus system established in 2011 has been employees could be encouraged to report
successful. However, the financial impact false earnings in order to receive higher
that this could make on their company could bonuses. Their must be a strong focus by
be substantial. the auditor on these possible falsifications.

Loans: There are multiple material loans that The auditor is responsible for analyzing
Lakeside has. each loan agreement to ensure proper
usage.

Rental Agreements: With many of the stores Examining each rental agreement to
occupying rented space, is there to need determine its qualification for proper
capitalize the lease? capitalization is a responsibility of the
auditor.
 Related party transaction: Roger opening up
a new location

(2) Based upon discussion in the case, prepare the auditor's report that King and
Company rendered at the end of the year 2011 engagement. How does this opinion differ
from a standard auditor's report? [Case1-2.doc] (not correct format refer to modules)
might be on midterm

Case 1 - Exercise 2

King and Company

PRO FORMA AUDITOR'S REPORT

To: The Board of Directors:

We have audited the accompanying balance sheet of Lakeside Company as of

December 31, 2011, and the related statements of income, retained earnings, and cash
flows for the year 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 audit.

We conducted our audit in accordance with generally accepted auditing

standards 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 audit provides a reasonable basis for our opinion.

In November of 2010, the Lakeside Company invested a fair amount of

resources in their sixth retail store located adjacent to a new shopping mall on the east
side of Richmond, Virginia. With less than 40 percent of its available space leased to
date, this store has proven unsuccessful. By not attracting the necessary traffic to this
location, they have not managed to reach their break-even point since opening and their
recovery of their investment is uncertain. In our opinion, it is possible that the asset’s
value are being materially misstated due to the continual reporting of these assets at
historical value. By reducing these assets to net realizable value, it will alleviate the
misstatement on their financials and be in accordance with generally accepted
accounting principles.

In our opinion, except for not disclosing the impairments present from the
improper valuation of assets, the aforementioned financial statements present fairly, in
all material respects, the financial position of the Lakeside Company at December 31,
2011, and the results of its operations and its cash flows for the year then ended in
conformity with generally accepted accounting principles in the United States of
America.

King and Company (signed), Certified Public Accountants

Date: September 23, 2019
(Vincent Reilly)

APPLY YOUR RESEARCH

Use library resources such as searchable databases to research the following topic.

(1) The periodic selection of a new auditing firm by a company is not an uncommon
practice. Write a report discussing auditor changes. Why do companies change
auditors? What kinds of disclosures are required when a company changes auditors?
Are companies allowed to merely "shop around" for the audit opinion they desire? Does
this seem ethical to you?

There are numerous reasons why a company may want to change auditors. First, the company
may change auditor to one who charges less. Each firm charges different prices, and
companies want to get the best quality of service for less. Another reason for switching is
relationship issues. Companies want to have excellent communication with auditors and vice
versa. Having good communication permits an audit to be completed more smoothly. Also,
when an audit is being done, both sides have to understand their responsibility and obligations.
When this isn’t comprehended issues will arise. Additionally, companies change auditor for ones
who have greater expertise in their industry. For an audit to be adequately completed, the
auditor must have some knowledge in the company. The greater the knowledge, the better the
audit can be completed. Lastly, change of auditor may be because of change in the company’s
management. By having new management in place, they may request new auditor or a
particular auditor. Issue of Independence, deference’s in opinion or just like to rotate firms.

The following steps are required when a company changes auditors according to Gilbert J.
Bradshaw:

1. File an 8-K with Item 4.01

 2. Disclose the date the auditor resigned, declined to stand for re-appointment, or was
dismissed.

3. Disclose whether the auditor provided an adverse opinion or qualifications within the
two most recent fiscal years and any subsequent interim period.

4. Disclose whether the Company’s audit committee recommended or approved the

change in accountants.

5. Disclose whether there was a disagreement between the company and the auditors
within the two most recent fiscal years and any subsequent interim periods.

6. Provide to the resigning or dismissed auditor a copy of the disclosure as soon as

possible but no later than the Form 8-K filing date;

7. Request a written response in a letter from the auditor addressed to the SEC
indicating whether the auditor agrees with the characterization of the dismissal or
resignation; and

8. File the auditor’s letter with the SEC as an exhibit to the 8-K (I like to do it with the
initial filing but you could amend it if you want) or no later than 10 business days
thereafter.

9. Sometimes the Auditor wants to file an interim letter, or a letter that has a very
detailed response and the auditor has 10 business days to file that letter with the
SEC. The Company must file it within 2 days of receipt from the auditor (my analysis
suggests that you could possibly file this up to 12 business days after the fact, but
come on, be safe and file it asap). (Bradshaw, 2015)

Opinion shopping is prohibited by the SEC but is still practiced by companies (Kenton, 2019).
Companies will search for favorable opinions regarding their financial status. They seek an
auditor who will render an unqualified opinion that finds the financial statements to be fairly
presented. Unfortunately, this isn’t ethical. The purpose of an audit is to ensure financial users
that the company’s financial statements are fairly present so that they can use it for decision
making. (Allison Diaz)

References:

Bradshaw, G. J. (2015, October 19). How Does a Public Company Disclose a Change in
Auditor? Retrieved from https://bradshawlawgroup.com/how-does-a-public-company-disclose-a-
change-in-auditor/

Kenton, W. (2019, March 12). Opinion Shopping. Retrieved from

https://www.investopedia.com/terms/o/opinionshopping.asp
PCAOB. (n.d.). AS 1005: Independence. Retrieved from
https://pcaobus.org/Standards/Auditing/Pages/AS1005.aspx