An opening for partnership had just been announced in the local office of Jakes, Anders, and Wilkes

(JAW), a regional CPA firm. The new partnership position, justified by increased revenues, was cause for

celebration among the managers aspiring to become partners in the firm. Competition mounted for the new

position once the announcement was made. Lewis Short, one of the senior audit managers, was the current

favorite for admission to the partnership. Lewis had consistently received favorable performance evaluations

from his superiors and had been viewed as being technically competent throughout his career. In his last annual

performance review as a senior manager, he was told that the only obstacle he had to overcome in order to be

admitted to the partnership was to demonstrate an ability to attract new clients. Lewis had been making himself

very visible in the business community by joining the local business and not-for-profit organizations and he was

becoming a local leader in a respected civic organization. This activity helped Lewis identify prospective clients

and resulted in the addition of several new clients to the firm. At this point, he needed just one or two new

clients to ensure his admission as a partner.

Section 1

During a round of golf with the controller of a local automobile dealership, Lewis asked his golf partner, Ted,

for possible new business leads. Ted thoughtfully considered the question and finally came up with a name. The

automobile dealership frequently sold purchase contracts to local financial institutions. Recently Eve Edwards,

the president of Famous Presidents Savings (Famous), mentioned to Ted that she was unhappy with her current

auditor and was considering a change. She complained about high audit fees and noted some difficulties

working with her current auditor. Ted suggested that Lewis contact Eve to determine whether she was serious

about switching auditors, but he warned that Eve was a tough businesswoman with a reputation for being

shrewd. Lewis was so delighted with the new lead that he happily picked up the tab for golf and lunch.

Lewis wasted no time arranging a meeting with Eve. Just as Ted said, Eve was unhappy with her current auditor

and very willing to consider a change. Lewis noted that a reputable firm had audited Famous the previous year

and, as far as he could tell, the accounting records appeared to be in reasonable order. Based on his experience

with similar clients, Lewis developed a tentative proposal to perform the audit of Famous for a fee slightly less

than the previous years fee. Eve quickly consented and agreed to notify her prior auditor. Permission was

granted for the prior auditor to talk freely with Lewis regarding Famous. According to Lewiss best estimates of

the time required and personnel to be assigned, JAW would be able to recover its normal billing rates for

services performed at the proposed fee amount. Lewis told Eve that the engagement, including the proposed

audit fee, could not be finalized until he performed a more thorough background investigation of Famous and

obtained approval of the JAW partners. This investigation, required by JAW prior to acceptance of all new ACCT4003 Auditing I

Assignment #2

clients, was to include a more in-depth financial review of the past five years, a credit check, and an evaluation

of the general reputation of Famous and Eve. JAW required Lewis to inform the Partner in Charge of Auditing,

Jane Grove, and to obtain a favorable vote of the local office partners prior to acceptance of the new client.

Section 2

The background review produced the following information:

A. Famous is a small, closely held, and well-established financial institution. It has operated successfully for 20

years under Eves leadership. Eve currently serves as Chairman of the Board of Directors and CEO of

Famous. Famous weathered a recent business recession and still maintained net income comfortably above

the average for peer financial institutions.

B. Eve has a reputation as an aggressive businesswoman who always lands on her feet. She has used sales of

short-term certificates of deposit (CDs) to raise cash quickly to take advantage of new business

opportunities. Similarly, she has sold large portfolios of loans to avoid reissuing CDs when interest rates

were not favorable. She personally supervises collection activities on difficult loans and one collection

agency owner familiar with Famous commented that there was not much opportunity left for collection after

Eve got through.

C. As of the previous audit, the total assets of Famous were approximately $10 million. Within the past five

years, the total assets had fluctuated from a low of $8 million to a high of nearly $20 million. Stockholders

equity was slightly larger than average when compared to similar financial institutions. Virtually all the debt

of Famous was related to depositor accounts, primarily CDs.

D. Lewis visited the predecessor auditor and was allowed to examine and copy some of the working papers

from the prior year's audit. He noted that there had been a few more adjusting journal entries proposed than

he normally would have expected. In discussing the adjustments with the predecessor auditor, Lewis noted

that it had been difficult for the predecessor auditor to convince Eve that the adjustments were necessary.

However, Eve eventually agreed to make a sufficient number of the proposed adjustments to receive an

unqualified audit opinion. As Lewis reached the end of his meeting the predecessor auditor said, Of course,

you hate to lose any client, but if we had to choose one to give up it would be Famous.

E. Most of the loans held by Famous came from used car dealers, small home repair and remodeling

contractors, and door-to-door salespeople in the area. These types of loans were often difficult to collect.

Eve discounted the loans heavily, paying only a fraction of their face value, and usually bought them with

recourse. Because Eve had demonstrated an ability to collect a high percentage of these loans, she always

had an ample supply of salespeople and small businesses willing to sell her their loans receivable.

F. Talks with the controller of Famous went reasonably well. The controller was very friendly and tried to be

helpful. Overall the accounting records appeared to be in reasonably good order. However, Lewis was not

impressed with the knowledge and abilities of the controller. The controller had completed a few accounting

courses, but did not have a degree in accounting and had not completed any professional certification

program in accounting (e.g., CPA, CMA).

G. Lewiss business contacts were willing to freely discuss their experience with Eve and with Famous. They

consistently depicted Eve as disciplined, aggressive, and shrewd. Within Famous she was viewed as direct,

overbearing, and intolerant of error.

H. Famous generally had a reputation for paying obligations on time or shortly after the due date. However, it

was common for Eve to take exception to the charges billed and it was common for her to attempt to

Page 3 of 5ACCT4003 Auditing I

Assignment #2

renegotiate the charges before making payment. The prior auditor had been paid within a reasonable time

after the completion of the engagement.

Lewis summarized his background review for Jane, noting the above points. All things considered, he

concluded that Famous would be an acceptable audit client and recommended to Jane that the engagement be

accepted by JAW. Lewis fully understood the importance of increased firm revenues to justify the new

partnership position. Annual employee reviews were scheduled the following week and this would be Lewiss

last opportunity to add another client before his evaluation for a partnership position. If Lewis was not admitted

to the partnership soon, he would likely be asked to leave the firm to make room for other promising candidates.

Required (12 marks):

Now assume the role of Lewis, and prepare a list of reasons for and against accepting the prospective client.

You should name at least six (6) reasons for and at least six (6) reasons against the acceptability, based on the

case materials provided above.