solutions 12e final

8/9/2019 Solutions 12e FINAL

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The Lakeside Company:Auditing Cases

SOLUTIONS MANUAL 12eTable o Contents

John M. Trussel and J. Douglas Frazer

A Note on Ethics, Fraud and SOX Questions 2

A Note on Research Assignments

3

Introductory Case 5

Case !

Case 2 22

Case 3 33

Case ! !!

Case 5 5"

Case # $!

Case $ "2

Case " %2

Case % &

Case & &

Case #

Case 2 25

Case 3 3#


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A NOTE ON ETHICS, FRAUD, AND SOX QUESTIONS

The Lakeside Company: Auditing Cases, 1th edition, has !een updatedin light o" the a##ounting s#andals o" the early $$$s, the passage o" the%ar!anes&'(ley A#t o" $$, and the rene)ed interest in ethi#s )ithin

the a##ounting and auditing pro"ession.

%ar!anes&'(ley issues ha*e !een in#orporated in t)o )ays. First, #ase#ontent has !een altered to in#lude Lakeside+s #onsideration o" nan#inge(pansion through an initial pu!li# o-ering, and the resulting impa#tsu#h a de#ision )ould ha*e on Lakeside and on A!ernathy andChapman, CAs. %e#ond, the dis#ussion /uestions and e(er#ises ha*e!een e(panded to in#lude #onsideration o" %ar!anes&'(ley and ne)auditing and independen#e standards, !oth !y adding a se#tion in theend&o"hapter material and !y re"eren#e in the other /uestions )hereappropriate.

0thi#s /uestions are no) spe#i#ally identied )ith an ethi#s logo. Theethi#s /uestions are o"ten open ended, and this solutions manual doesnot try to gi*e e(a#t ans)ers to these /uestions. ather, )e intend togi*e some ideas "or #lassroom dis#ussion, and to help )ith studentresear#h on these /uestions.

Fraud /uestions are no) spe#i#ally identied )ith a "raud triangle.Fra

ud

Fra

ud


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A NOTE ON RESEARCH ASSIGNMENTS

The "Apply Your Research" and "Consulting Partner Review" assignments

included at the end of several cases do not lend themselves to definitivesolutions that could be included in an instructor's manual. The assignments aresimply not intended to be eercises in arriving at a predetermined answer.Rather! the applications of the suggested readings have the following obectives#

$ To provide a means for improving the writing s%ills of students. &rom allreports! accounting maors too often leave college lac%ing in the basicability to compose and construct sentences and paragraphs. Accountingand auditing especially as one moves up in an organi(ation) obviouslyre*uire s%ills other than the purely *uantitative. +emos! reports!footnotes! audit and accounting guides! etc.! all re*uire accountants and

auditors to be effective communicators of the written word. ,ndeed! theinstructor may want to team up with a member of the school's -nglish or communications department to enhance the effectiveness of theseassignments. The auditing instructor can then evaluate the technical andresearch portions of the assignment! while the -nglish instructor wouldma%e suggestions as to grammar! synta! construction of sentences andparagraphs! logic of the thought process! etc. As a preliminary step! theinstructor may want to assign articles such as "ord Crunching# A Primer for Accountants" from the +arch /001 issue of the Journal of

Accountancy .

$ To introduce students to accounting and business ournals as well as other important publications. After college! students must be able to "%eepcurrent" or their effectiveness will *uic%ly decline. ,n most cases! thiscontinuation of their education is provided by the regular reading of publications such as The Wall Street Journal, Journal of Accountancy,CPA Journal ! and Forbes. These assignments re*uire the students tobegin reading these ournals prior to graduation. The students shouldbecome comfortable with their ability to understand and use the materialsin professional publications. ,n addition! real$world aspects of manyaccounting issues are presented through these various readings.

$ To develop the students' ability to derive viable solutions to auditingproblems. 2nfortunately! students in college often come to the belief thatall auditing issues can be resolved simply by applying thepronouncements of various authoritative bodies. Tetboo%s too oftenpresent problems that have one ultimate answer. 3owever! in many realcases! no definitive solutions actually eist. Thus! when faced with suchproblems! students must be capable of reviewing the available literatureand then using that information as a basis for arriving at a wor%able


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decision.

$ To promote auditing research. ,n most of these library assignments!students are provided with one or more resources as starting points for their research. 3owever! the instructor should always push the students to loo%

for more and different types of information. The ultimate purpose of theseassignments is to force the students into the library and online sources to dothe searching for themselves. 4ne ecellent method of introducing theassignments is to use some class time to illustrate the various methods of research that are available to them! including electronic resources! such asthe following#

o http#55www.sec.gov

o http#55www.PCA4627.org

o http#55www.A,CPA.org

o http#55www.&A76.org

o Your state society of CPAs also operates sites.

,f possible! a business librarian or a research librarian may be enlisted todiscuss the various search techni*ues that can be used at the school'slibrary for research purposes. 8eveloping the ability to find information isone of the most important s%ills that can be achieved by an accountingmaor.

http://www.sec.gov/http://www.pcaobus.org/http://www.aicpa.org/http://www.fasb.org/http://www.sec.gov/http://www.pcaobus.org/http://www.aicpa.org/http://www.fasb.org/


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INTRODUCTORY CASE

SU""#ST#$ ANS%#&S TO $ISCUSSION 'U#STIONS

/)

The staff auditor performs many of the detailed audit procedures! such aspreparing and controlling accounts receivable confirmations. ,n general the wor%of the staff auditor is controlled by the audit program and supervised by thesenior auditor.

The senior auditor coordinates the audit at the client's location and performsmany of the more difficult audit procedures! such as analytical reviewprocedures. 2sually the detailed wor% performed by the audit senior is moresophisticated and re*uires the eperience gained by someone holding that ran%.

The audit senior is supervised by the manager.

The manager and the partner have supervisory roles. +anagers and partnersoften have more than one audit team under supervision at any given time.

The partner is the person who has responsibility for determining whether thefirm9s signature can be attached to audit report.

:)

The partner$in$charge of an audit is the definitive decision$ma%ing position on theaudit team. Although the manager and senior auditor ma%e several decisions!they must get ultimate approval from the partner$in$charge of the audit. Theconsulting partner's role is to add a further degree of obectivity to the audit. Theconsulting partner reviews and criti*ues certain crucial decisions made by theaudit team! such as the final audit report. The partners should be rotated toassure independence.

7arbanes$4ley 74;$7:1


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should be selected based solely on the *uality of its service. >o reliable systemeisted! though! for conveying such information to potential clients. 3ence! firmswith many clients tended to remain large! while smaller firms often found growthto be nearly impossible. ,n the free mar%et system espoused by the 2nited7tates! restrictions on such practices as advertising and solicitation were

inevitably overturned. 4ver the past three decades! attitudes toward mar%etinghave changed dramatically as competition has become much more intense. Advertisements by CPA firms in newspapers and maga(ines are now common.>ewsletters such as that distributed by Abernethy and Chapman are alsofre*uently used to increase a firm's name recognition in the business community.

,n the current world of business! some type of mar%eting strategy seemsimperative if an accounting firm is to compete. hether that mar%eting shouldetend to formal advertising is often a *uestion of firm policy. +ost importantly!the firm must ensure that potential clients %now of its presence and the servicesthat it offers. A client will probably not select a CPA firm based on advertising.

3owever! the client may initially become aware of the firm only through sometype of mar%eting.

,nterestingly! some members of the accounting profession view mar%eting ashaving had a negative impact on the profession as a whole. Price competition for new clients is often associated with the mar%eting of a firm. These critics assertthat lowered fees result in sloppy and hurried audit wor% that can decrease theoverall reputation of the profession. Additional resources discussing this issuecan be found in the "7uggested Readings" at the end of this case.)

?)

A national or international CPA firm might consider ac*uiring Abernethy andChapman for several reasons#

$ Although only a regional firm! Abernethy and Chapman apparently has aclient base that includes a number of large clients in several differentindustries. 6y ac*uiring the local firm! the larger organi(ation willfre*uently be able to retain these customers! thus increasing its own clientlist.

$ The larger firm may be interested in moving into this geographical region!and buying the local firm will provide an instant base on which to build apractice in the area.

$ The larger firm may already have an office in this location and feels thatcombining the practices will reduce epenses.

Abernethy and Chapman might have several reasons for viewing an ac*uisitionin a favorable light#


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$ &re*uently! the purchase price will be a considerable amount of moneybecause of the goodwill inherent in an established accounting firm. Theoffer to sell may be especially tempting if the partners are nearingretirement age and the future of the firm appears uncertain.

$ The smaller firm may have trouble dealing with increased competition frombigger firms. 4ften clients may decide that a change to a nationally %nownCPA firm should be made to add etra stature to the audit report. ,f a localorgani(ation has only a few large clients! it cannot economically afford tolose a significant amount of revenue in this way. A merger may help thefirm to %eep its clients.

$ The regional firm may also desire the additional bac%up services offered bylarge organi(ations. >ational CPA firms usually have eperts in manyindustries as well as in specific audit areas who are available for

consultation. ,n a smaller firm! this degree of assistance is not alwaysavailable when a difficult accounting or auditing problem is encountered.

$ PCA46 registration and 7-C practice presents hurdles that might beovercome through a merger with a larger firm.

+any mergers have occurred in the auditing profession during recent years.Critics assert that this trend has reduced competition and will inevitably lead to adecrease in audit *uality. Proponents counter by stating that mergers lead tomore efficient operations and! thus! improve audit *uality. 4bviously! mergerswill create a drastic change in the profession as more of the smaller firms

disappear. Audit wor% in this country may possibly become concentrated withinthe largest CPA firms. hether this result is good for the auditing profession maybe merely a *uestion of perspective. To the smaller firms struggling to surviveand grow! the mergers are usually considered a threat as the bigger firmsbecome more competitive. To the larger firms! the chance for continued growthand more efficient operations is always an important obective.

7ee the 7arbanes$4ley section below for a follow$up *uestion related to theimpact of 74; on the auditing profession.

@)

+oving staff from one area of a CPA firm to another can cause the perception of an independence problem. &or eample! the appearance of independence maybe in *uestion if a member of the consulting staff helps to install a newaccounting system for a client and then she moves to the audit staff to audit thissame client.

7ee the 7arbanes$4ley section below for a follow$up *uestion5answer related to


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the impact of 74;! in particular the list of proscribed activities for registered CPAfirms.

SU""#ST#$ ANS%#&S TO #(#&CIS#

/)

The *uestion re*uires students to address all the elements of a *uality controlsystem! as included in Statement on Quality Control Standards No. 2 . ,n somecases! students should recogni(e the need for additional information.

To# 8eAnna +alott&rom#8ate#Re# uality Control 7tandards at Abernethy and Chapman

4verview# , was employed by the firm of Abernethy and Chapman to review the*uality control standards within the firm. The following represents my evaluation ofthese standards according to the si elements re*uired by the A,CPA.

-valuation#Standa)d #*isting

+)o,edu)es&e,ommendations Additional

Ino)mationNeeded

=eadershipresponsibilities

•The case does

not eplicitly

address thisstandard.3owever! the firmhas some itemsin place! such asa partnerdedicated tomonitoring thesystem.

•The firm should have

policies in place that

establish the Btone atthe top for *ualitywithin the firm.

•hat specific

policies does the

firm have todemonstrateleadershipresponsibilities for *uality within thefirmD

Relevantethical

re*uirements

•&irm re*uires its

employees to

sever allfinancial ties toaudit clients.

•The A,CPA's Code of

Professional

Conduct does notre*uire allemployees to severties with all auditclients. &oreample! staffauditors not wor%ingon a particular

•The case does

not mention

spouses ordependents ofthe employees.7pouses anddependents mustalso beindependent! asdefined by


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engagement neednot sever ties. ,n thiscase! the firmeceeds theminimum level of

conduct forindependence.

•The case does not

address other ethicalre*uirements.

7ection /11$$Rule /1/ of theCode. ,n thiscase! the firmshould

strengthen itsre*uirements.

•3ow does the

firm meet otherethicalre*uirementsD

Acceptanceandcontinuation ofclients

•This case does

not address thiscontrol standard.,t does note thatthe firm is

attempting togain more clientsthrough anetensivemar%etingprogram.

•,t is important to

have many controlswhen considering apotential client! sothat the potential

ris%s of legaleposure are not toogreat. >ote# Thistopic is addressed inCase :.)

•

3umanresources

•The firm

considerseperience and

technicalcompetence inassigningpersonnel toauditengagements.

•The firm hires

only collegegraduates with amaor inaccounting and

re*uires thateachprofessional sitfor the CPAeam within oneyear ofemployment.

•The firm re*uires

•This appears to be a

reasonable *ualitycontrol.

•This seems to be a

more than ade*uate*uality controlprocedure. ,n fact!many firms hire

professionals! suchas computer eperts!who were notaccounting maors.

•+any states re*uire


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?1 hours ofcontinuingeducation peryearE however!the case does

not address theissue of the typeof educatione.g.! accountingand auditingversus othercourses).

• The firm

promotionproceduresconsider

seniority andtechnicalcompetence!which seems tobe an ade*uatecontrol.

that a minimumnumber of continuingprofessionaleducation hours bein accounting$ and

auditing$relatedcourses.

•The case does

not address theissue ofassessment of

technicalcompetence.+any firmsre*uire a writtenassessment ofperformanceafter eachengagement.

-ngagementperformance

•The firm re*uires

that a consulting

partner beassigned to eachauditengagement.The consultingpartner assuresthat the wor%performed by theengagementteam meetsapplicable

professionalstandards andregulatoryre*uirements.This helps toensureobectivity! as theconsulting

•The firm should have

a mechanism for

consultation withauthoritativeliterature and othersources! includingoutside eperts! if itsprofessional stafflac%s epertise in aparticular area.

•,t is not clear from

the case how the

team documentsthe wor%performed on anauditengagement. Anevaluation ofauditdocumentation isnecessary forcompleteevaluation of the

*uality controls.


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auditor is not adirect part of theengagement.

•The firm seems

to have a clear

chain ofcommand andade*uatesupervision onthe audit. Thestaff auditorsreport to thesenior auditor!who in turnreports to themanager. The

partner$in$charge has anoverallsupervisoryposition.

+onitoring•The firm has a

partner! 8eAnna+alott! assignedto monitor the*uality control

standards.

• A comprehensive

system ofdocumentation of the*uality controlsshould be developed.

•The case does

not mention whattypes ofdocuments arere*uired to

support thesecontrols! butdocumentation isetremelyimportant. &oreample! manyfirms re*uireemployees tosubmit a listing of all financial tiesto companies so

that the firm canmonitor itsindependence.

Conclusion# The firm has many policies related to *uality control standards.3owever! the firm has room for improvement in many of the areas! particularly inthe acceptance and continuation of clients.


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SU""#ST#$ ANS%#&S TO SA&-AN#S.O(L#/ 'U#STIONS

/)

7tudents should be encouraged to visit the PCA46 website

http#55www.pcaobus.org) when answering this *uestion#

$ Registration F CPA firms must be registered to be associated with publiccompanies. The application for registration is an online process. There is a fee! itis small relative to other costs of maintaining the registered status and changingthe nature of the firm to comply with PCA46 rules. 3ere is the fee structure fromtheir website#

$ ,nspection $ The PCA46 operates a system of inspections and publici(esthe results! per its authority under the 74; Act#

& The A#t pro*ides that an inspe#tion shall in#lude at least the

"ollo)ing three general #omponents:2 An inspe#tion and re*ie) o" sele#ted audit and re*ie)engagements o" the rm, per"ormed at *arious o3#es and !y*arious asso#iated persons o" the rm42 An e*aluation o" the su3#ien#y o" the /uality #ontrol system o" the rm, and the manner o" the do#umentation and#ommuni#ation o" that system !y the rm4 and2 er"orman#e o" su#h other testing o" the audit, super*isory,and/uality #ontrol pro#edures o" the rm as are ne#essary orappropriate in light o" the purpose o" the inspe#tion and theresponsi!ilities o" the 5oard.

& egular inspe#tions are on a three&year #y#le, although smallerrms may !e less "re/uent. %pe#ial inspe#tions #an !e re/uired !y theCA'5.

$ Maintenan#e o" independen#e under CA'5 rules and %'6&

http://www.pcaobus.org/http://www.pcaobus.org/


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pros#ri!ed a#ti*ities:

Proscribed activities under 74; section :1/)#7ection :1/# 7ervices 4utside The 7cope 4f Practice 4f AuditorsE Prohibited

Activities.

,t shall be "unlawful" for a registered public accounting firm to provide any non$audit service to an issuer contemporaneously with the audit! including# /)boo%%eeping or other services related to the accounting records or financialstatements of the audit clientE :) financial information systems design andimplementationE


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$ A,CPA uality Control 7tandards for public company audits are summari(edat# http#55cpcaf.aicpa.org5Resources5
http://cpcaf.aicpa.org/Resources/http://cpcaf.aicpa.org/Resources/

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