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Homework answers / question archive / Auditing Standards Case Study
Auditing Standards Case Study. Ray, the owner of a small company, asked Holmes, CPA, to conduct an audit of the company's records. Ray told Holmes that the audit was to be completed in time to submit audited financial statements to a bank as part of a loan application. Holmes immediately accepted the engagement and agreed to provide an auditor's report within three weeks. Ray agreed to pay Holmes a fixed fee plus a bonus if the loan was granted. Holmes hired two accounting students to conduct the audit and spent several hours telling them exactly what to do. Holmes told the students not to spend time reviewing the 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 Ray's financial statements. The students followed Holmes's instructions and after two weeks gave Holmes the financial statements, which did not include footnotes. Holmes 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 Ray had changed the accounting standard for capitalizing interest.
Required:
Briefly describe each of the generally accepted auditing standards and indicate how the action(s) of Holmes resulted in a failure to comply with each standard.
General Standards
1. The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor.
2. In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors.
3. Due professional care is to be exercised in the planning and performance of the audit and the preparation of the report.
Holmes students were inadequately trained for an audit. Independence was compromised by the bonus fee contingent on results. Planning and performance was almost non-existent.
Standards of Field Work
1. The work is to be adequately planned and assistants, if any, are to be properly supervised.
2. A sufficient understanding of internal control is to be obtained to plan the audit and to determine the nature, timing, and extent of tests to be performed.
3. Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit.
Holmes students were not properly supervised. Internal Control was ignored; the purpose of IC is to determine the extent of testing required. Failed again. Proving the accuracy of the math in the general ledger is not evidential matter. There was no testing, no analysis, and no inquiry of company personnel.
Standards of Reporting
1. The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles.
2. The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period.
3. Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report.
4. The report shall either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. When an overall opinion cannot be expressed, the reasons therefor should be stated. In all cases where an auditor's name is associated with financial statements, the report should contain a clear-cut indication of the character of the auditor's work, if any, and the degree of responsibility the auditor is taking.
The report attached to the financial statements is the most important part of the work in telling the reader whether the financial statements fairly present the financial information about the company. The report is used to declare issues that are NOT in compliance with generally accepted accounting principles, and to state to what extent those exceptions negate the presentation of the data. The opinion clarifies that position. Readers of financial statements are careful to understand any deviations from a 'clean' opinion. In Holmes case, there is a departure from GAAP which Holmes did not qualify his opinion for.
Informative disclosures, also known as footnotes, are an prescribed inclusion in an audited financial statement. Those notes tell the reader about the nature of the business, the methodology of recording revenue and expenses, the details of any long term debt, equity issues, ongoing litigation, and anything else that a reader might need to know to form an basis for understanding and accepting the company's financial statements as presented.
