Case 5-3 Reauditing Financial Statements

Margaret Dairy is a CPA and the managing partner of Dairy and Cheese, a regional CPA firm located in northwest Wisconsin. She just left a meeting with a well-respected regional credit union headquartered in her hometown. Margaret was asked whether her firm would be willing to reaudit the previous years' financial statements and, subsequently, conduct an audit of the current years' financials. This is the first time Margaret has been asked to conduct a reaudit, although she realizes it has become more common as a result of problems like Enron and WorldCom experienced. Some companies switching auditors have elected to have the new audit firm re-examine prior-period financial statements because of concerns about the quality of the earlier audit.

On her way back to the office, Margaret calls her brother Mark, who is a Senior Audit Manager at a firm in Margaret's hometown, to share her good news. She tells him that doing the audit work for the two years will increase her firm's revenue by 10%. Mark is taken aback by the news. The new client was a client of Mark's firm. He did not know the firm had lost the client and it might be picked up by Dairy & Cheese.

Questions 1.What issues should be of concern to Margaret in deciding whether Dairy and Cheese should accept the reaudit engagement?

2.What are Mark's ethical obligations in this matter? Should he discuss the situation with Margaret? How about bringing it up at his firm?

3.Regardless of your answer to part 2, what inquiries should Margaret make of the predecessor auditor?

4.Assume Margaret's firm discovers undetected fraud in the previous years' financial statements, what should she do?