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Week 3 Homework Questions
1)
The following questions are based on the same scenario I used for question 3 in your week
1 homework. That question addressed violations of the Code of Conduct. I want to apply
the same scenario to legal liabilities. Here is a copy of the scenario:
John Smith owns a small, privately held firm. He hired you to audit its financial statements. He
told you that the audit was to be completed in time to submit audited financial statements to a
bank as part of a loan application. You immediately accepted the engagement and agreed to
provide an auditor's report within three weeks. John agreed to pay you a fixed fee plus a bonus if
the loan was granted. You hired two accounting students to conduct the audit and spent several
hours telling them exactly what to do. You told the students not to spend time reviewing John's
internal controls but instead to concentrate on proving the mathematical accuracy of the ledger
accounts and on summarizing the data in the accounting records that support John's financial
statements. The students followed your instructions and, after two weeks, gave you the financial
statements, which did not include footnotes. You studied the statements and prepared an
unqualified auditor's report. The report, however, did not refer to generally accepted accounting
principles or to the fact that John had changed to the accounting standard for capitalized interest.
Here are the new questions:
a)
After the audit was completed, John used the financial statements to secure a loan
from a bank. Within a year, John was unable to make payments on the loan. In the
process of investigating the reason why, the bank determined that the financial
statements were material misstated. John, however, was near bankruptcy and could
not pay off the loan. The bank sued you for the balance due on the loan. Given the
violations I discussed in my solution to the week 1 homework, do you think the bank
will prevail? You answer should provide an analysis of the legal issues involved to
include what basis the bank would have to sue, what you level of liability would
be(proportionate or joint and several), and a clear statement of why or why not you
think the bank would prevail to include how effective your defenses might be.
b)
Now assume that instead of applying for a bank loan, John used the financial
statements as part of a prospectus for an initial public stock offering (IPO), i.e.,
John's firm sold stock directly to the public. A potential investor read the prospectus
and did a comprehensive analysis of the financial statements as a basis for his
decision to buy a significant portion of stock in the new corporation. A year later,
the firm was doing so badly that its stock price was down to 10% of what it was after
the IPO. The investor sued both the John's new corporation and you for his
investment losses. During the trial, the investor was able to show that the financial
statements were materially misstated in key areas that affect firm value. Given the
violations I discussed in my solution to the week 1 homework, do you think the
investor will prevail? You answer should provide an analysis of the legal issues
involved to include what bases (cover all that apply) the investor would have to sue,
what you level of liability would be(proportionate or joint and several), and a clear
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statement of why or why not you think the investor would prevail to include how
effective your defenses might be.
2)
The text lists 18 audit objectives - 8 for balances, 6 for transactions, and 4 for presentation
and disclosure. For each of the following audit procedures, list the category and specific
objective each tests and provide an explanation of why you selected the category and
object. Some of these audit procedures test more than on objective and I want you to list
and explain all that apply. Assume all procedures were executed on the audit for a fiscal
year ending December 31, 2014. Fill in the following table to answer the question. I have
filled in the first item as an example.
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Audit Procedure
Category
Objective
Explanation
1. Examine sales invoices for the last
five sales transactions recorded in the
sales journal in 2014 and examine
shipping documents to determine they
are recorded in the correct period.
Balance
Cutoff
The cutoff object is to determine that transactions recorded near the end of an
accounting period are included in the correct period. The text is unclear here
because it states that balance-related objectives are applied to balance sheet
accounts and sales is an income statement account. However, I believe the
procedure still fits the cutoff objective.
Transaction
Timing
This procedure would also test whether the transaction was recorded on the
correct date. Since transactions that are recorded at the end of the year also are
recorded during the year, this objective also would apply.
2. Add all customer balances in the
accounts receivable trail balance and
agree the amount to the general
ledger.
3. Determine whether long-term
receivables and related party
receivables are reported separately in
the financial statements.
4. For a sample of shipping
documents selected from shipping
records, trace each shipping document
to a transaction recorded in the sales
journal.
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Audit Procedure
Category
Objective
Explanation
5. Determine whether all risks related
to accounts receivable are adequately
disclosed.
6. Examine a sample of duplicate
sales invoices to determine whether
each one has a shipping document
attached.
7. Inquire of the client whether any
accounts receivable balances have
been pledged as collateral on longterm debt and determine whether all
required information is included in
the footnote description for long-term
debt.
8. Send letters to a sample of accounts
receivable customers to verify
whether they have an outstanding
balance at December 31, 2014
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Audit Procedure
Category
Objective
Explanation
9. For a sample of sales transactions
selected from the sales journal, verify
that the amount of the transaction has
been recorded in the correct customer
account in the accounts receivable
ledger.
10. Foot the sales journal for the
month of July and trace posting to the
general ledger.
11. For a sample of customer
accounts receivable balances at
December 31, 2014, examine
subsequent cash receipts in January
2015 to determine whether the
customer paid the balance due.
12. Discuss with the credit department
personnel the likelihood of collection
of all accounts as of December 31,
2014 with a balance greater than
$100,000 and greater than 90 days
old.
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