Question

1. For each of the following independent situations (a – k), describe the most appropriate course of action that the auditors should take.

A. While reviewing audit documentation, Tyson Michaels, a partner at K&O was reviewing working papers as part of the firm’s system of quality control. Tyson noted that after releasing an audit report related to the financial statements of a publicly traded client, it does not appear that any tests were conducted to evaluate the need for impairment of the carrying value of the Company's property, plant, and equipment. These tests are important with respect to supporting the audit opinion.

B. Prior to the audit completion date (April 1, 2015), an auditor learned that their audit client Bubbagump Inc., had declared a significant dividend payable to its shareholders. This dividend was declared on March 14, 2015, to be paid to Bubbagump’s shareholders of record on May 16, 2015.

C. Pat Colt completed the December 31, 2014, audit of Manning and issued an unmodified opinion on Manning's financial statements dated March 15, 2015. Colt's opinion was released, along with Manning's financial statements, on March 21, 2015. During a review of Manning's first quarter 10-Q in late April, Colt became aware of the company's settlement with a customer over a product warranty lawsuit; this case had been settled on March 17, 2015. Although Colt had received the necessary letter from Manning's attorneys, the letter arrived prior to the settlement of the case and did not mention this development. After reviewing the information related to the settlement, Colt does not believe that the settlement is material to Manning's financial condition or results of operations and believes the opinion on Manning's financial statements is still supportable.

D. During a PCAOB inspection, it was determined that WKRP, LLP had not adequately documented their rationale for not observing the physical inventory count in its audit of King Manufacturing. This discovery occurred over a full year after the audit report release date. Lebron McWhiney, the lead engagement partner conceded that the inventory observation had not occurred and alternative procedures were not available due to the client’s accounting record retention policies. In discussions with the PCAOB investigators Lebron noted that the rationale, although not documented, was that King’s year-end inventory is quantitatively immaterial, at just 1% of total assets.

E. Drew Allison is conducting the audit of Anderson Inc. as of December 31, 2014. At the beginning of the evidence gathering, Allison becomes aware that one of Anderson's major customers (Jones) is experiencing significant financial difficulties. Jones normally accounts for 5 percent of Anderson's net sales. After performing the necessary procedures, Allison believes that $2.8 million of Jones's receivable balance will ultimately become uncollectible. Allison further believes this amount is material to Anderson's financial condition and results of operations.

F. Charles Carmelo is completing the December 31, 2014, audit of Nugget Company. As part of the final procedures, Carmelo has requested representations from Nugget's management regarding their assertion as to the fairness of the financial statements and other important matters addressed by professional standards on February 5. Because Nugget's management is attending an analyst briefing in the upcoming week, Carmelo receives these signed representations dated February 9, 2015. Because Carmelo had already completed all of the important procedures he released his auditor’s report, dated February 5, 2015, with the financial statements on February 6.

G. Gruden LLP, was auditing Raider Company for the year ended December 31, 2014. Gruden plans on completing the audit by February 17, 2015. On January 17, 2015, Gruden LLP learned that Raider Company activated a portion of its line of credit on January 5, 2015, by borrowing $2.5 million. This additional obligation increased Raider Company's long-term liabilities by 10 percent.

H. Cameron Alta completed the December 31, 2014, audit of Saxe Company on February 10, 2015. Saxe is planning to release its financial statements, along with Alta's opinion on these financial statements and internal control over financial reporting, on February 17, 2015. On February 12, 2015, a flood in one of Saxe's warehouses located in the Gulf Coast region destroyed more than $10 million of inventory. The extent to which this loss is recoverable through Saxe's insurance is unlikely, Alta believes that this loss could have a material impact on Saxe's financial condition and results of operations.

I. During the audit of Glomco, Angel Myron identified a number of misstatements. These misstatements are not material in dollar amount, do not appear to represent any discernable pattern, and do not represent fraudulent activity. As a result, Myron has decided that Glomco's financial statements do not need to be adjusted to reflect the effect of these misstatements.

J. Crismus and Stori, LLP is auditing Frozen Pole Desserts (FPD) for the year ended December 31, 2014. On February 9, 2015, the audit partner in-charge Ralphy, learned of the following events during his meeting with FPD's chief operating officer. A class action lawsuit was brought against FPD by some of its former employees for workplace discrimination. An attorney on behalf of a class of employees filed the lawsuit on January 10, 2015. The letter from FPD's attorneys suggested that the amounts are not estimable and the likelihood of a negative outcome cannot be determined at this time.

K. Following the completion of the 2014 audit (including the release of the audit report) of Blankenship Corporation, by SeeanSee, Muzik, and Fakdurry, LLC (SMF). Reese Jill, SMF’s audit partner met with the manager on the audit engagement to conduct a postmortem on the engagement and identify how changes in Blankenship's operations noted during the most recent audit may affect future audits. During this review, Jill became aware that Blankenship's process for evaluating potential impairment of goodwill related to an acquisition made by Blankenship during the most recent year had been considered and calculated by the audit team, but for unknown reasons the adjustment had not been proposed to the client. Thus, the impairment had not been properly disclosed or accounted for in the financial statements. Jill believes that the results of the procedure is important in supporting the opinion on Blankenship's financial statements and notes that Blankenship’s management would probably be receptive to adjusting the financials.

Required: Unless otherwise noted, assume that each scenario affect (are material) to the Company’s financial statements, and there are persons who continue to rely on the financial statements. For each of the preceding items, determine:

I. whether the event described should be classified as:

A. Subsequent Event

B. Subsequently Discovered Event

C. Omitted Procedure

D. None of the above

II. what actions the auditor should take after the firm's quality review identified these issues:

1) Disclosure in financial statements

2) Adjustment to and/or disclosure in the financial statements

3) No further action is necessary (specific audit procedures)

4) Determine if alternative procedures are available, if so take action 5, if procedures are not available, withdraw the auditor’s report

5) Perform procedures related to the item and revise the auditor’s report date if necessary

6) Perform procedures related to the items and if facts would result in revision of auditors’ report or financials, then notify individuals relying on financials and issue revised financials which provide disclosure of facts

7) Not applicable

Answer 1

A) A procedure to evaluate the need for impairment of carrying value of Company's Property, plant and equipment has been omitted. The auditor should perform procedures related to the items and if facts would result in revision of auditor's report or financials, then notify individuals relying on the financials and issue revised financials which provide disclosure of facts.

B) The dividend has been declared after the financial year i.e. 31 December. Hence, there will not be a revision in the financials. However, before the audit completion date the auditor has learned that significant dividend has been declared, it is a subsequent discovered event and the same needs to be disclosed in financial statements by way of notes to accounts.

C) A subsequent event which would influence the reader of the financial statements is material. In that case, the audit report or the financials need to be modified. In the above case, the settlement was a subsequent event but as per the auditor's opinion the event is not material and will not affect the financial condition or the results of the company. Hence no action is required to be taken.

D) In this case the auditors were not able to perform alternative procedures due to client's accounting record retention policies. Though the inventory amounts to 1% of the total assets which may be immaterial but there may be a possibility of material misstatement in the financial statements due to fraud or error. If the auditor was not able to perform alternative procedures then the auditor should withdraw the audit report.

E) In this case, the event that one of the major customer of the Company was in financial difficulties was existing as on the balance sheet date. Hence an adjustment to and disclosure in the financial statements need to be done as it is material to the company's financial condition and results of operations.

F) It is an omitted procedure. The auditor should not have released the audit report and the financials before Management Representation Letter. The auditor should withdraw the auditor's report or release the auditor's report or financial statements after the receipt of Management Representation Letter.

G) It is an event in the regular course of business and no action needs to be taken as on Dec 31, 2014 financials.

H) In this case, the event occurred after the balance sheet date. It is a subsequent event and the auditor should disclose it in financial statements by way of notes.

I) If a misstatement has been identified though not material but there is a likelihood of material misstatement in the financial statements due to error or fraud. The auditor should perform additional procedures.

J) It is a subsequent event and should be disclosed in the financial statements.

K) In this case the auditor should have proposed about the impairment as it is material to the financial statements. The auditor should perform procedures related to the items and if facts would result in revision of auditor's report or financials, then notify individuals relying on financials and issue revised financials which provide disclosure of facts.