Question

Halvorson & Co., CPAs, was hired as the auditor for Machinetron, Inc., a company that manufactured highprecision, computer-operated lathes. The owner, Al Trent, hired Halvorson to conduct the upcoming audit and assist with an initial public offering registration with the SEC. Because Machinetron’s machines were large and complex, they were expensive. Each sale was negotiated individually by Trent, and the sales often transpired over several months. Improper recording of one or two machines could represent a material misstatement of the financial statements. The engagement partner in charge of the Machinetron audit was Bob Lehman, who had significant experience auditing manufacturing companies. He recognized the risk for improper recording of sales, and he insisted that his staff confirm all receivables at year end directly with customers. Lehman conducted his review of the Machinetron audit files the same day that Trent wanted to file the company’s registration statement for the initial public stock offering with the SEC. Lehman saw that a receivable for a major sale at year-end was supported by a fax, rather than the usual written confirmation reply. Apparently, relations with this customer were “touchy,” and Trent had discouraged the audit staff from communicating with the customer. At the end of the day, there was a meeting attended by Lehman, Trent, the underwriter of the stock offering, and the company’s attorney. Lehman indicated that a better form of confirmation would be required to support the receivable. After hearing this, Trent blew his stack. Machinetron’s attorney offered to write a letter to Halvorson & Co. stating that in his opinion, a fax had legal substance as a valid confirmation reply. Lehman, feeling tremendous pressure, accepted this proposal and signed off on an unmodified audit opinion. Any comments to Lehman?

Answer 1

Here,Al Trent seems to have been keen on filing his company’s registration statement for the initial public stock offering with the SEC, at which time , Bob Lehman found out a material mis-statement of the financial statements ,that are needed to be filed in support to the SEC.

The latter was the fall-out of a receivable for a major sale at year-end was supported by a fax, rather than the usual written confirmation reply--that too when Machinetron's relationship with that particular customer does not appear to be so-very encouraging--needing the latter's additional confirmation of the same.

Additionally ,Trent had limited the scope of the audit-team by limiting their inter-action with this customer--so they were not able to confirm over phone, the fax message verbally ,or contact them in any other be-fitting manner.

so,emphasis of the receivable balance --that too when the amount involved is material & significant--owed by this customer was not possible for the audit team, to form an opinion ,in their report.

Lehman was forced to to issue an unmodified report, under pressure, even though he had disputed in sufficient measure.

Moreover, as the attorney of the company , tried to contact Halvorson & Co, the audit firm directly, to settle matters in their favor,over-stepping Lehman's arguments,the latter was left with no other option, but to toe the line.

Now,

As all these were not recorded & only remained verbal, & also as Lehman issued an unmodified audit report,

1.He is very likely to be held responsible for his assurance about the veracity of the supporting documents filed with the SEC.

2. and these documents ,available at the SEC ,are certain to be perused by the potential investors

3.Halvorson & Co, the audit firm & Lehman as one who issued the unmodified report , are answerable to the SEC, for misleading the potential investors, with an incorrect audit report.

4.as this mis-statement is material enough to affect the decision of those investors,whether to invest or not.

5. Even though Lehman could not operate independently,ultimately, his written acceptance of the financial statements will only stand.

In light of the above, Lehman has only 2 options before him:

i.can place all facts before his firm and try to persuade Machinetron to do what is right, ie . Either to leave out that receivable altogether or obtain the customer's confirmation.

or

ii.if the above is not possible, should excuse himself from this assignment, immediately, without concurring.