Behavioral Recognition Systems (BRS) Inc. Case

Davis, the CEO of BRS Inc., hired LBB & Associates Audit Firm to conduct audits for BRS, which LBB did for the years 2010 through 2014. Lopez served as the Engagement Partner for the 2010 through 2012 audits and Engagement Quality Review Partner for the 2013 and 2014 audits. LBB has two partners and approximately eight accountants on staff, with Carlos Lopez as the Managing Partner.

For the 2012 audit, LBB were aware that BRS was a high-risk audit client based in part on their prior audit work for BRS. BRS had no Chief Financial Officer and relied on a single part-time bookkeeper to maintain its accounting records. BRS never had an Audit Committee, and the board of directors consisted only of Davis and another BRS executive. Lopez knew BRSs board did not convene a single meeting in 2012. At the time of the 2012 audit, all respondents were also aware of control deficiencies in BRSs internal control environment, including a lack of controls over Daviss unrestricted ability to authorize, approve, and direct payments and expenses. LBB noted in the 2012 audits Risk Assessment Summary Form that management override of internal controls presented a significant risk in connection with the audit. LBB further indicated that they would not test or rely on BRSs internal controls during the audit, but would rather base the audit on substantive testing. In 2012 BRS lost one of its major long-term projects, which would significantly reduce revenue for the next 3 years; also, the company needed funding for research and development. BRS subsequently obtained consulting services from a related party, Apple limited, to determine the way forward for the company (BRS Inc.).

During the 2012 audit, Lopez was aware of several red flags indicating possible existence of unidentified related party transactions. Particularly, in response to an audit questionnaire, BRS claimed that there were no related party transactions in 2012, but Lopez knew that that response was inaccurate, because he had knowledge of recurring transactions with at least two related parties, based on his work on prior BRS audits. Despite his awareness of these red flags, Lopez did not execute any audit procedures during the 2012 audit to identify whether material related party transactions existed. Rather, Lopez relied exclusively on BRSs Inc., management to identify related party transactions, and did not perform standard procedures for identifying related parties. In 2012, BRS paid Blackstone a related party approximately $1.5 million, which comprised approximately 9.2% of BRSs total operating expenses. Lopez's analysis of the 2012 audit also showed that BRSs consulting expenses had increased almost ten-fold from 2011 to 2012, including a three-fold increase in expenses for related party Apple Limited. Specifically, consulting expenses increased from approximately $113,000 in 2011 to approximately $1.17 million in 2012 (approximately 7.2% of BRSs total operating expenses for the year). In both years, the majority of BRSs consulting expenses were associated with related party, Apple Limited. Despite these issues and others that amounted to material misstatements, LBB issued a standard unqualified report to BRS in 2012.

REQUIRED:

QUESTION #1. (15 marks)

a) List three (3) control deficiencies that existed at BRS Inc. (3 Marks)

b) What impact will LBBs assessment of control risk have on the level of substantive testing and detection risk in the evaluation/audit of the expenditure cycle? (6 marks).

c) State three (3) audit procedures that LBB & Associates Audit Firm should execute during its substantive testing of BRS Inc expenditure cycle (6 marks)

QUESTION #2. (10 marks)

a) Based on the information presented in the case, describe two (2) potential going concern issues at BRS Inc. (4 marks)

b) State three (3) audit procedures (specific to the items in (i) above) that LBB & Associates Audit Firm should conduct to verify BRS Inc ability to continue as a going concern (6 marks)

QUESTION #3 (20 marks)

a) Given the situation that exist at BRS Inc, what four (4) audit procedures are required by LBB & Associate Audit Firm to demonstrate proper assessment of the related party transactions at BRS Inc. (6 marks)

b) Prepare a footnote disclosure (information) that LLB and Associate Audit firm should include in BRS Inc audited financial statements regarding the related party transactions. (4 marks)

c) Given the information detailed in the case, what type of audit report LLB & Associate Audit firm should have issued? Provide two supporting evidences to justify your decision. (5 marks)

d) Draft ONLY the audit opinion paragraph that would be included in the audit report that LLB & Associate should have issued (based on your answer in part c above). (5 mark)

QUESTION #4 (15 marks)

a) Describe two (2) breaches of the Rule of Conduct committed by LBB & Associates Audit Firm along with the potential ramifications. Cite specific situation(s) from the case. (5 marks)

b) Let's suppose that after the issuance of the initial 2012 audit report, BRS Inc, had to file for bankruptcy in 2013, due to financial statement fraud. Accordingly, in 2013, BRS Inc., Board of Directors filed a lawsuit against LBB & Associates Audit firm for negligence in the execution of the 2012 audit. What would be LBB & Associates Audit firms best defense against BRS Inc., against the lawsuit, to minimize or obviate liability. Cite specifics from the case to support your answer. (10 marks)