James Carson and Martin Tighe, CPAs have audited all of the accounts on the balance sheet....

James Carson and Martin Tighe, CPAs have audited all of the accounts on the balance sheet. James Carson argues with Martin Tighe that since retained earnings is a balancing account, it requires no further examination. Martin Tighe, however, disagrees and argues that they should still choose to audit retained earnings. Who do you agree with and why?

Expert Solution

Martin Tighe is right about the need to audit reatined earnings. Retained earnings is not just a balancing account, it is the most important account under shareholders capital. There is no much activity under retained earnings, but the final outcome of all transactions (ie. Profit or loss on the business) will refelect retained earning account. Another probable activity in retained earnings is dividends issue and payment. The same needs to be audited on a sample basis, for statutory as well as fiduciary purposes. The most important activity under retained earnings that an auditor should focus on is, the prior period adjustments. Prior period adjustments do not reflect anywhere in the financial statements other than the retained earnings. This is an are with high risk for fraud from the top level management, because there will be no real changes, only book values will be effected, thus is unoticed. So an auditor should look into each of these adjustments, check the materiallity, verify that the adjustments are in conformity with accounting principles etc.

From the above, one can conclude that Martin Tighe is right about the need to audit retained earnings account.

ekkarill92 answered 2 years ago

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