In 2002, the audit frm Arthur Andersen collapsed following charges brought against it in the United

States relating to the failure of its client, Enron. Some other clients announced that they would be

dismissing Arthur Andersen as their auditor even before it was clear that Arthur Andersen would not

survive.

Required

Using the theories outlined in this chapter on the demand for audits, explain some reasons why these

clients took this action.

The management of Mitchell Labs decided to go private in 2002 by buying all 3.50 million of its outstanding shares at $25.50 per share. By 2006, management had restructured the company by selling off the petroleum research division for $14.75 million, the fiber technology division for $7.50 million, and the synthetic products division for $23 million. Because these divisions had been only marginally profitable, Mitchell Labs is a stronger company after the restructuring. Mitchell is now able to concentrate exclusively on contract research and will generate earnings per share of $1.20 this year. Investment bankers have contacted the firm and indicated that if it reentered the public market, the 3.50 million shares it purchased to go private could now be reissued to the public at a P/E ratio of 14 times earnings per share.

a. What was the initial cost to Mitchell Labs to go private? (Do not round intermediate calculations. Round your answer to 2 decimal places. Enter your answer in millions, not dollars (e.g., $1,230,000 should be entered as "1.23").)
  

b. What is the total value to the company from (1) the proceeds of the divisions that were sold, as well as (2) the current value of the 3.50 million shares (based on current earnings and an anticipated P/E of 14)? (Do not round intermediate calculations. Round your answer to 2 decimal places. Enter your answer in millions, not dollars (e.g., $1,230,000 should be entered as "1.23").)
  

c. What is the percentage return to the management of Mitchell Labs from the restructuring? Use answers from parts a and b to determine this value. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
  

Under Section 404 of the Sarbanes-Oxley Act of 2002, what is the independent auditor's responsibility?

According to the Sarbanes-Oxley Act of 2002, management is responsible for establishing a control environment, assessing risks it wishes to control, specifying information and communication channels and content (including the accounting system and its reports), designing and implementing control procedures, and monitoring, supervising, and maintaining the controls.

As Internal/Forensic Auditor, I made multiple recommendations to management relative to eliminating inefficiencies in the business process. Some of my recommendations were ignored and the inefficiencies were allowed to continue. Management felt the risk exposure related to the inefficiencies was not significant.

Considering this, do you believe management should be free to make their own judgments about the necessary extent of controls?  

In 2002, Congress passed the Body Armor Act that made it illegal for anyone who has been convicted of a violent felony to possess body armor. Cedrick Alder- man was convicted of violating the statute, and he then challenged the law’s constitutionality during appeal. Alderman contended that Congress had exceeded its authority because the law was not sufficiently related to interstate commerce.

CASE QUESTIONS
1. Is the Body Armor Act constitutional?

2. If Alderman purchased the body armor in the state where it was manufactured, how did his purchase

affect “interstate” commerce?

3. Suppose Congress enacts a prospective law prohibiting all private persons from purchasing or owning body armor in the future. In your opinion, would such a law be constitutional?

The Public Company Accounting Oversight Board (PCAOB) was created by Congress when the SOX of 2002 was passed. The PCAOB assumed the auditing standard responsibilities that had been formally tasked to the American Institute of Certified Public Accountants (AICPA).

• In your opinion, has the PCAOB been more successful than the AICPA in addressing fraud in auditing standards?
• Do you think the PCAOB has done a better job than the AICPA in completing the basic functions and reaping the benefits of auditing, including the role of materiality in selecting audit tests and processes? Give reasons.
• Do you think the PCAOB has clarified and enhanced the effectiveness of auditors' responsibilities to prevent and detect fraud changed under the PCAOB versus the AICPA?

In the year 2002, approximately 22.5% of the U.S. population were currently smokers. We wonder if in Tennessee the proportion of current smokers was also 0.225 or if it was higher than that. Assume that in that year, a survey was conducted in Tennessee, and that a simple random sample of 2466 individuals were selected. Out of the 2466, 611 were classified as ’current smokers’.

We wish to conduct the test of hypothesis.

(a) State the appropriate null and alternative hypothesis.

(b) Calculate the test statistic using the Central Limit Theorem.

(c) Using the previous result, find the p-value.

(d) State your conclusion.

The management of Mitchell Labs decided to go private in 2002 by buying all 2.90 million of its outstanding shares at $24.20 per share. By 2006, management had restructured the company by selling off the petroleum research division for $10.50 million, the fiber technology division for $9.20 million, and the synthetic products division for $19 million. Because these divisions had been only marginally profitable, Mitchell Labs is a stronger company after the restructuring. Mitchell is now able to concentrate exclusively on contract research and will generate earnings per share of $1.30 this year. Investment bankers have contacted the firm and indicated that if it reentered the public market, the 2.90 million shares it purchased to go private could now be reissued to the public at a P/E ratio of 14 times earnings per share.

a. What was the initial cost to Mitchell Labs to go private?

b. What is the total value to the company from (1) the proceeds of the divisions that were sold, as well as (2) the current value of the 2.90 million shares (based on current earnings and an anticipated P/E of 14)?

c. What is the percentage return to the management of Mitchell Labs from the restructuring? Use answers from parts a and b to determine this value.

In order to preserve auditor independence, the Sarbanes–Oxley Act of 2002 restricts the types of nonaudit services that auditors can perform for their public‐company audit clients. The list includes nine types of services that are prohibited because they are deemed to impair an auditor's independence. Included in the list are the following: Financial information systems design and implementation Internal audit outsourcing Describe how an auditor's independence could be impaired if she performed IT design and implementation functions for her audit client. Likewise, how could an auditor's involvement with internal audit outsourcing impair his or her independence with respect to auditing the same company?

Gloucester Ltd. manufactures specialized valves. For the first six months of 2002 the company reported the following operating results.

Fixed costs included in cost of goods sold in the period were $800,000; fixed costs included in selling and administrative expenses were $60,000.

Gloucester recently received a special order from an overseas industrial customer, Brewery Supply Industries (BIS), for 9,000 brewery valves at a price of $36.50 each. Accepting the order would increase variable selling and administrative expenses by $0.75 per unit because of additional shipping costs, but it would not increase fixed costs or any other unit variable costs.

Assume that Gloucester currently has just sufficient excess capacity to fill this one-time order which will take 6 months to fill.

Ignore income taxes.

Required

1. Moira Keating, VP Sales, wants to know how profitable this special order would be. Prepare a financial analysis of this order for Ms Keating.

2. Ms Keating has some additional questions regarding the BIS order:

1. What is the break-even selling price per unit?
2. What selling price would be required to produce a contribution margin of $6.00 per unit?

C. Identify and briefly justify what you would consider to be the two most important factors that are not directly financial and that management should consider in making its decision?

D. Ms Keating, VP Sales, is still unsure about the wisdom of accepting the BIS order. She has asked you to prepare a full report dealing with all the relevant issues and make a recommendation to her as to whether Gloucester Ltd. Should accept this order. Justify your conclusion, citing all relevant factors, quantitative and qualitative, including those that have been raised in your answers above.