In 1980, Frank Sinopoli, a 27-year-old accountant, accepted a job offer from a CPA firm based in Dallas, Texas. Four years later, Sinopoli became a partner with the firm. Perkins, Dexter, Sinopoli & Hamm (PDSH ) provided accounting and accounting-

related services to small- and medium-sized businesses located principally in the Dallas–Fort Worth Metroplex. During his long tenure with PDSH , Sinopoli supervised a wide range of engagements. Those engagements included the 2000 through 2005 audits of a small brokerage firm, Geo Securities, Inc.

Geo Companies of North America (GCNA ), a Dallas-based oil and gas exploration company, organized Geo Securities as a wholly-owned subsidiary in June 1996. The sole business purpose of Geo Securities was to market interests in oil and gas properties owned or controlled by GCNA . Similar to GCNA , Geo Securities was not a public company. However, because Geo Securities was a registered broker-dealer with the Securities and Exchange Commission (SEC), its annual financial statements had to be audited by an independent accounting firm.

Throughout the six-year period that Sinopoli supervised the annual audits of Geo Securities, the company was entangled in two civil lawsuits filed in a federal district court in Georgia. The two principal defendants in these lawsuits were GCNA and Geo Securities. The primary allegation filed against the defendants was that they had “fraudulently offered and sold”1 joint partnership interests in oil and gas properties.

In 2004, the Georgia federal court ordered the defendants to pay a nominal amount of damages, approximately \($217,000\), to the plaintiffs to settle the two civil lawsuits.

The court also appointed an arbitrator to determine whether the plaintiffs would be entitled to recover some or all of their sizable attorneys’ fees from the defendants. In April 2005, three months before Geo Securities’ 2005 fiscal year-end of July 31, 2005, the arbitrator ruled that GCNA , Geo Securities, and the other defendants in the civil lawsuits–who were individuals affiliated with the two companies–would be required to reimburse the plaintiffs for \($949,688\) of legal fees they had incurred in pursuing the case. The defendants were jointly and severally liable for those legal fees. GCNA had informed Geo Securities and the other defendants that it would pay the \($217,000\) settlement but did not make such a commitment regarding the much larger arbitration award.

GCNA , Geo Securities, and the other defendants appealed the 2004 court-ordered settlement and filed a challenge to the 2005 arbitration decision. Because Geo Securities’

management believed that GCNA would pay the full amount of the arbitration award, if it was not overturned, the company did not record a contingent liability or loss related to that award in its accounting records. Instead, the company disclosed the arbitration award in a financial statement footnote accompanying its 2005 financial statements............

Questions:-

1. When auditing contingent liabilities, which of the management assertions discussed in the professional auditing standards are of primary concern to an auditor? Explain.
2. The SEC criticized Frank Sinopoli for not sending an “audit inquiry letter” to Geo Securities’ external legal counsel. Describe the nature and purpose of such a letter. Do you agree with the SEC that Sinopoli should have contacted Geo Securities’ external legal counsel?
3. Under what circumstances must audit procedures be applied to supplemental information accompanying a client’s financial statements? Describe the responsibilities auditors have when auditing such information.
4. Under what circumstances, if any, are auditors required to assess the going concern status of an audit client? What procedures should auditors apply when performing such an assessment?