i need this by early morning. His mother later remarried--a fellow named MacAdam--and Johnny grew up in his stepfather's home with his mother, stepfather, sisters, brothers, and the stepfather's children. Even though this was his stepfather, Johnny actually had a closer relationship than with his natural father, who had moved out of state when he received a promotion at work. Johnny was never adopted by Mr. MacAdam, and kept the O'Boy family name. Johnny G. O'Boy grew up and became an accountant. He went to work for a large office of a large CPA firm. So far, he has progressed from being a fresh-out-of-school kid to being an incharge accountant who is responsible for running the field work portion of an audit. (Note: The field work is the work done at the client's place or places of business.) Since he has done so well, he has progressed, and lately he was assigned to be the incharge accountant running the audit of XYZ Corp., one of the largest audits done by that office of that accounting firm. He has brought in the file of audit working papers for your review. You notice that the chief financial officer of the audit client company is named MacAdam. You also find in the work papers--loose, not bound as part of the work papers--a handwritten note to Johnny from MacAdam ("From the desk of....") which begins, "Son, bring home a birthday cake tonight so we can give your mother her presents. Also, let's talk about whether it is time for you to sell some of your shares in XYZ. You have been buying shares with your birthday money for years, and by now you have so much of your net worth wrapped up in XYZ that you probably ought to sell at least some of your shares so you can diversify." Required: a. What are the ethical responsibilities of you and your firm in this situation? b. What should be the outcome of this situation? Why? c. If you are satisfied that all the audit procedures have been done properly and that the financial statements fairly present the financial position, results of operations, and cash flows, what kind of report should your firm issue? Why?

Copies of tests First test of semester Accounting 457/557. First test: Advanced Auditing fall semester 2001 General instructions: a. You may keep these test questions. answers. b. For this test, you may use the Codification, but not the textbook. c. The point values for these questions are as follows: 1 2 3 4 5 6 7 8 Turn in only your 20 20 25 5 5 5 10 10 100 Question 1 The parents of Johnny G. O'Boy divorced when he was still young. His mother later remarried--a fellow named MacAdam--and Johnny grew up in his stepfather's home with his mother, stepfather, sisters, brothers, and the stepfather's children. Even though this was his stepfather, Johnny actually had a closer relationship than with his natural father, who had moved out of state when he received a promotion at work. Johnny was never adopted by Mr. MacAdam, and kept the O'Boy family name. Johnny G. O'Boy grew up and became an accountant. He went to work for a large office of a large CPA firm. So far, he has progressed from being a fresh-out-of-school kid to being an incharge accountant who is responsible for running the field work portion of an audit. (Note: The field work is the work done at the client's place or places of business.) Since he has done so well, he has progressed, and lately he was assigned to be the incharge accountant running the audit of XYZ Corp., one of the largest audits done by that office of that accounting firm. He has brought in the file of audit working papers for your review. You notice that the chief financial officer of the audit client company is named MacAdam. You also find in the work papers--loose, not bound as part of the work papers--a handwritten note to Johnny from MacAdam ("From the desk of....") which begins, "Son, bring home a birthday cake tonight so we can give your mother her presents. Also, let's talk about whether it is time for you to sell some of your shares in XYZ. You have been buying shares with your birthday money for years, and by now you have so much of your net worth wrapped up in XYZ that you probably ought to sell at least some of your shares so you can diversify." Required: a. What are the ethical responsibilities of you and your firm in this situation? b. What should be the outcome of this situation? c. If you are satisfied that all the audit procedures have been done properly and that the financial statements fairly present the financial position, results of operations, and cash flows, what kind of report should your firm issue? Why? Why? Question 2 A lawyer has been contacted by someone who wants to sue an accounting firm for an allegedly bad audit performed by the accounting firm. The audit client has already filed for bankruptcy, and the individual who contacted the lawyer lost a bundle of money that he had loaned to the audit client. The lawyer has contacted you to see if you might be interested in working on the case. He tells you that he is interested in whether the auditors performed their work with the same standard of care as is normally expected of members of the profession. He allows you to sit there and examine the set of audit work papers which the auditors had prepared when they did the audit. From looking through the work papers, you see that the auditors traced the balance of accounts receivable to the total of the detailed records for each customer. The balance did not agree, but the auditor doing that work noted that there had not been a problem with this client the previous year, so he passed on the matter instead of investigating it. There was no other work done in the receivables area. There was not any verification with customers of the balances claimed to be owed to the audit client company, there was not any testing done to be sure that shipments resulted in invoices which were then posted to accounts receivable, and there was not any testing done to be sure that amounts in accounts receivable actually represented sales to customers. When you ask the lawyer for more information, he tells you that the allegation is that most of the accounts receivable never even existed; instead, the company simply had documentation parties at night after the auditors had left for the day, during which they prepared phony documents to give to the auditors the next day. How did client personnel know what phony documents to prepare? Why, they simply received a listing from the auditors of what documents the auditors wanted, and the auditors were willing to wait up to a week to receive the documents. Required: a. Does the accounting firm which did the audit and issued an unqualified opinion appear to be vulnerable? b. If so, why? c. Correctly cite any authoritative professional literature which supports your answer. If not, why not? Question 3 You have graduated from Jackson State University and accepted an offer from a CPA firm. After learning the ropes on the audit staff, you have been put in charge of the audit of a new client. Yesterday, the client's president signed an engagement letter to have the CPA firm perform the audit for the current fiscal year. The client company is a multi-branch bank which has operations in three states. You have never audited a bank before. Required: a. What should you do before taking your audit team out to the client's headquarters location? (This includes any work which you do alone at the client's location.) b. What work papers should you prepare to document what you have done? Question 4 (Review question 4-7 from page 101, which had been assigned as homework) Explain how the rules concerning stock ownership apply to partners and nonpartners. Give an example of when stock ownership would be prohibited for each. Question 5 (Review question 5-7 from page 131, which had been assigned as homework, but slightly reworded) A common type of detect a fraud. discovery. Give correctly citing lawsuit against CPA's is for the failure to State the auditor's responsibility for such authoritative support for your answer by the authoritative professional literature. Question 6 (Review question 8-19 from page 239, which had been assigned as homework) Define what is meant by a tick mark. What is its purpose? Question 7 Accountants should expect that their work will be audited by other accountants. Auditors will examine the work of other accountants, and the work of people besides accountants, to ascertain whether that work has been done in compliance with the specified procedures and whether the work meets standards. The homework assignment for the first chapter we went over this semester included the following: Prepare a memo for me on the subject of professional skepticism, based on what you find (and properly cite) in the authoritative professional literature. You have been provided with another student's memo. Required: Audit this student's memo. a. Whose memo are you auditing? b. Does the memo deal with professional skepticism? c. Does the memo properly cite the authoritative professional literature? Compare the memo's citation(s) to your own copy of the Codification. d. Does the memo fulfill all the requirements listed in the homework? e. Given your answers to parts a through d above, recommend a grade of any whole number from zero to ten for the memo. If the memo does not deal with professional skepticism, or if it does not properly cite the professional literature, then recommend a zero. If it passes both of parts b and c, you may recommend any score up to ten. Scoring: Your score on this answer will depend on how well you evaluate the other student's memo. Question 8 (There is not any question to be answered. This is simply the score for your memo, as determined by the teacher, but using another person's suggested score as an input to the decision process.) Accounting 457/557. First test: Advanced Auditing fall semester 2002 General instructions: a. You may keep these test questions. answers. b. For this test, you may use the Codification, but not the textbook. c. The point values for these questions are as follows: 1 2 3 4 5 6 7 8 Turn in only your 20 20 20 8 8 8 8 8 100 Question 1 You are working for a CPA firm and have just been named as the in-charge person running the audit of XYZ Company. XYZ is the biggest client of the CPA firm and pays your employer, the CPA firm, more than any other client. Consequently, it is a great honor for you to be put in charge of the annual audit. In the course of doing your planning, you notice the following: 1. The engagement letter says that the fee for the audit will be five million dollars if the audit opinion is unqualified, two and a half million dollars if the audit opinion is qualified, and one hundred thousand dollars if the report disclaims an opinion. The client will not pay any fee at all if the audit opinion is adverse. 2. You do not know the audit partner well, but you do know one of the members of the client's top management very well. That individual is the spouse of the audit partner. 3. You just completed some work you were doing on the CPA firm's own retirement plan and trust, and you know that twenty percent of the value of the trust is invested in securities of XYZ Corporation--the client you are about to audit. Required: a. What are the ethical responsibilities of you and your firm in this situation? b. What should be the outcome of this situation? c. If you are satisfied that all the procedures have been done properly and that the financial statements fairly present the financial position, results of operations, and cash flows, what kind of report should your firm issue? Why? Why? Question 2 A lawyer has been contacted by someone who wants to sue an accounting firm for an allegedly bad audit performed by the accounting firm. The audit client has already filed for bankruptcy, and the individual who contacted the lawyer lost a bundle of money that he had loaned to the audit client. The lawyer has contacted you to see if you might be interested in working on the case. He tells you that he is interested in whether the auditors performed their work with the same standard of care as is normally expected of members of the profession. He allows you to sit there and examine the set of audit work papers which the auditors had prepared when they did the audit. From looking through the work papers, you see that the auditors traced the balance of inventory to the total of the detailed records for each item in inventory. The balance did not agree, but the auditor doing that work noted that there had not been a problem with this client the previous year, so he passed on the matter instead of investigating it. There was no other work done in the inventory area. There was not any observation of the client's taking a physical inventory, there was not any test of valuation of individual items of inventory, and there was not any testing done to be sure that all inventory had been included in the count. When you ask the lawyer for more information, he tells you that the allegation is that much of the inventory never even existed; instead, the company simply had documentation parties at night after the auditors had left for the day, during which client personnel prepared phony documents to give to the auditors the next day. How did client personnel know what phony documents to prepare? Why, they simply received a listing from the auditors of what documents (e.g., physical inventory count tickets, standard cost sheets) the auditors wanted, and the auditors were willing to wait up to a week to receive the documents. Required: a. Does the accounting firm which did the audit and issued an unqualified opinion appear to be vulnerable? b. If so, why? c. Correctly cite any authoritative professional literature which supports your answer. If not, why not? Question 3 You have graduated from Jackson State University and accepted an offer from a CPA firm. You have progressed within the firm, and have already run some audits as the in-charge person. One of the other in-charge accountants got very sick, and will be out from work for at least a few weeks, so the partners have asked you to take over an audit engagement which is about to start. Just in the normal course of reviewing last year's work papers to see what was done and what modifications should be made for this year's audit, you see a lot of notations that the audit staff members on the audit asked client personnel various questions, recorded the answers, and that was the end of what the auditors did. Some of the biggest numbers in the financial statements turn out to be representations of Johnny Thompson, whom you know from your days at college together. His reputation there was that he was such a smooth liar, even when people knew he was lying, they still would not do anything about it. For example, his girlfriend was seen wearing an expensive ring identical to one which had mysteriously disappeared only days earlier from Bill's room. Bill was a fraternity brother of Johnny Thompson. When I say identical, I mean identical, right down to the engraving on the inside of the ring: "To Susan from Bill." Johnny's girlfriend, who was wearing the expensive ring Johnny gave her, was named Martha. Required: a. What should you do before taking your audit team out to the client's headquarters location? (This includes any work which you do alone at the client's location.) b. What work papers should you prepare to document what you have done? Question 4 (Review question 4-7 from page 101, which had been assigned as homework) Explain how the rules concerning stock ownership apply to partners and nonpartners. Give an example of when stock ownership would be prohibited for each. Question 5 (Review question 5-7 from page 131, which had been assigned as homework, but slightly reworded) A common type of lawsuit against CPA's is for the failure to detect a fraud. For example, Arthur Andersen gave unqualified opinions to WorldCom's financial statements which showed that WorldCom had a net income in the hundreds of millions of dollars, although WorldCom later restated its financial statements because it had actually lost billions of dollars. State the auditor's responsibility for such discovery. Give authoritative support for your answer by correctly citing the authoritative professional literature. Question 6 (Review question 8-18 from page 239, which had been assigned as homework) Why is it essential that the auditor not leave questions or exceptions in the working papers without an adequate explanation? Question 7 (Review question 8-4 from page 238, which had been assigned as homework) What factors should an auditor consider prior to accepting an engagement? Explain. Question 8 Chapter 4 of the textbook concerns professional ethics, and Chapter 5 concerns legal liability. According to what has been reported in the news, many of the top personnel of Arthur Andersen knew that the financial statements of Enron were not accurate, but Enron personnel were told to clean up the financial statements over a period of ten years. According to what has been reported in the news, WorldCom, another Andersen client, reported hundreds of millions of dollars of profit during a time when WorldCom actually lost billions of dollars. Either Andersen personnel did know the true results of WorldCom's operations or Andersen personnel did not know the true results of WorldCom's operations. Despite what has happened with these and other audit clients, very few auditors have been charged with anything by the federal government (e.g., the SEC and the U.S. Department of Justice). Required: Why bother complying with the law and with professional ethics when these agencies do not do anything anyway? Accounting 457/557. First test: Advanced Auditing fall semester 2003 General instructions: a. You may keep these test questions. answers. b. For this test, you may use the Codification, but not the textbook. c. The point values for these questions are as follows: 1 2 3 4 5 6 7 8 Turn in only your 20 20 20 8 8 8 8 8 100 Question 1 You are working for a CPA firm and have just been named as the in-charge person running the audit of XYZ Company. XYZ is the biggest client of the CPA firm and pays your employer, the CPA firm, more than any other client. Consequently, it is a great honor for you to be put in charge of the annual audit. In the course of doing your planning, you notice the following: 1. The engagement letter says that the fee for the audit will be five million dollars if the audit opinion is unqualified, two and a half million dollars if the audit opinion is qualified, and one hundred thousand dollars if the report disclaims an opinion. The client will not pay any fee at all if the audit opinion is adverse. 2. You do not know the audit partner well, but you do know one of the members of the client's top management very well. That individual is the spouse of the audit partner. 3. You just completed some work you were doing on the CPA firm's own retirement plan and trust, and you know that twenty percent of the value of the trust is invested in securities of XYZ Corporation--the client you are about to audit. Required: a. What are the ethical responsibilities of you and your firm in this situation? b. What should be the outcome of this situation? c. If you are satisfied that all the procedures have been done properly and that the financial statements fairly present the financial position, results of operations, and cash flows, what kind of report should your firm issue? Why? Why? Question 2 A lawyer has been contacted by someone who wants to sue an accounting firm for an allegedly bad audit performed by the accounting firm. The audit client has already filed for bankruptcy, and the individual who contacted the lawyer lost a bundle of money that he had loaned to the audit client. The lawyer has contacted you to see if you might be interested in working on the case. He tells you that he is interested in whether the auditors performed their work with the same standard of care as is normally expected of members of the profession. He allows you to sit there and examine the set of audit work papers which the auditors had prepared when they did the audit. When you ask the lawyer for more information, he tells you that the allegation is that much of the money in the bank never even existed; instead, the company simply had documentation parties at night after the auditors had left for the day, during which client personnel prepared phony documents to give to the auditors the next day. How did client personnel know what phony documents to prepare? Why, they simply received a listing from the auditors of what documents (e.g., bank statements, bank reconciliations) the auditors wanted, and the auditors were willing to wait up to a week to receive the documents. From looking through the work papers, you see that the auditors traced the balance of "cash in bank" to the total of the general ledger accounts for each bank account. You see that one of the new junior accountants on the audit had gone to work for the accounting firm after first working at a different accounting firm, and had put a note into the work papers that the accounting firm should not render its audit opinion until the auditors had first sent confirmation requests to the banks, received those confirmations, had first sent requests for cut-off statements to the banks (cut-off statements are bank statements covering a short period after the close of the client's fiscal year), received those cut-off statements, and tested the bank reconciliations which had been prepared by the client. You also see in the work papers that the in-charge accountant had written a note to that new junior accountant: "Not enough time in budget. Dummy up work papers to look like you did the work. Then destroy this note from me to you." You are convinced that if the client company had actually owned that much money on deposit at the bank, it would have been in good shape. Instead, because it did not have that money, that client company filed for Chapter 7 bankruptcy (Chapter 11 = reorganization; Chapter 7 = liquidation). Required: a. Does the accounting firm which did the audit and issued an unqualified opinion appear to be vulnerable? (Remember that the standard the lawyer told you is whether the "auditors performed their work with the same standard of care as is normally expected of members of the profession.") b. If so, why? c. Correctly cite any authoritative professional literature which supports your answer. If not, why not? Question 3 The in-charge accountant on the audit is the only person from the accounting firm, working at the client's place of business, who has any experience at doing audit work. Everybody else who is working on the audit is a fresh-out-of-school junior accountant who started working for the accounting firm less than a month ago. The in-charge accountant seems very distracted, as though he does not have his mind on the audit engagement at all. Every time you or any of the other junior accountants walks into his private office, he is on the telephone talking with one or another person, trying to find a new job with a different employer. One day, because he likes you so much, he tells you that he has just burned out on public accounting. He thinks it might be his own fault; he wanted to be a hero in the firm, so he cut the time budgets on most of his jobs (client engagements), then put in a lot of unrecorded hours to get the jobs done within his own unrealistically low time budgets. This has led to some frustration on your part and also on the part of the other junior accountants. It is rare for any of you to see the in-charge accountant; he just tells you to "follow what they did last year" and give him the work papers when you have finished. He never looks at the completed work papers; he just gives them an index number, cross-references them to the balances they allegedly support, and inserts them into this year's audit file. You may or may not have heard of Murphy's Law: if anything can go wrong, it will, and at the worst possible time. About two years later, the accounting firm gets sued for doing a bad audit. The lawyers for the other side subpoenaed the work papers. Some of the junior accountants had not bothered to do the same work as the previous year; instead, they just put down on the work paper the amount of the balance in the general ledger, put a tick mark there and explained that the tick mark meant that that amount had been traced to the general ledger, and wrote down the conclusion that the balance was correct because the balance shown on the auditor's work paper agreed with the balance shown in the general ledger. None of the audit work done in the previous year was done in that year by those junior accountants. Now you realize how they had the time to sit there in an office at the client's place of business, watch sports on TV, and keep telephoning their bookies to place illegal bets. Required: Are there any problems with this situation? If so, what are they? Correctly cite the authoritative professional literature as appropriate. Question 4 (This addresses the subject matter of Review Question 4-14 on page 99, which had been assigned as homework, but the wording in this question is different.) Some forms of advertising and marketing by CPA's are permitted, but other forms of advertising and marketing are prohibited. Required: a. What forms of advertising and marketing are permitted? b. What forms of advertising and marketing are prohibited? Question 5 (Review question 5-7 from page 127, which had been assigned as homework, but slightly reworded) A common type of lawsuit against CPA's is for the failure to detect a fraud. A type of lawsuit which may be in the process of becoming more common is for the detection of a fraud, but failure to publicize it. For example, the auditor of Spiegel Inc. has been criticized for determining that its correct audit report should include a going-concern qualification (meaning that the audit firm had serious doubt about the ability of Spiegel Inc. to continue in business for a period of one year beyond the date of the financial statements). According to what I read in The Wall Street Journal, Spiegel Inc. simply refused to file its audited financial statements with the SEC. Its audit firm apparently never told the board of directors about its opinion on the financial statements, never told the SEC that anything was amiss, and never withdrew as the auditor. Consequently, Spiegel was pretending that things were okay when they were not okay. Required: State the auditor's responsibility for discovery of the client's true financial position (balance sheet) and true earnings (income statement). Give authoritative support for your answer by correctly citing the authoritative professional literature. Question 6 (This is Review Question 8-1 on page 221, which had been assigned as homework.) What benefits does the auditor derive from planning audits? Question 7 (This is Review Question 8-15 on page 221, which had been assigned as homework.) Define client business risk and describe several sources of client business risk. What is the auditor's primary concern when evaluating client business risk? Question 8 This test covers Chapter 4, professional ethics Chapter 5, legal liability, and Chapter 8, audit planning and documentation. Write your own question about any of these topical areas, and then answer it. The question should be one which is worth at least eight points. Accounting 457/557. First test: Advanced Auditing fall semester 2004 General instructions: a. Some students have used white-out (or equivalent) on previous test papers. Do not use any such product. Do not tear any paper out of the book. Anyone who uses white-out or tears paper should expect to lose points. b. You may keep these test questions. Turn in your answers in the examination booklet. c. For this test, you may use the Codification, but not the textbook. You may not have any communications device with you--no cellular telephones, beepers, twoway (nor one-way) Dick Tracy wristwatch radios, communicating calculators, etc. d. Let the point values guide you for the approximate maximum times to spend on your answer to each question, where one point equals one minute. The point values for these questions are as follows: 1 2 3 4 5 6 7 8 20 20 20 8 8 8 8 8 100 Question 1 You are running the field-work portion of the audit of QRS, Inc., a NASDAQ-listed company, which is the biggest audit client in your office of a regional accounting firm. This is the first year your firm is doing the audit; the client left one of the gigantic accounting firms to come as a client to your firm. Some of the partners did the new-client investigation before deciding to accept this company as a client, and you have in your file a copy of the materials received from the predecessor audit firm. Nothing in those materials looks out of line. The chief financial officer of QRS says that they told Wall Street to expect earnings of $1.14 a share, but they intend to report $1.15. Right now, they are at $1.10 per share, so he wants to know from you what expenses he should defer to next year so that they can report $1.15. He explains that the gigantic accounting firm had usually gone along with what they, QRS, had suggested to the auditor in charge, but that in recent years, the auditor in charge had told them what accounts to use and that he would instruct the audit team not to look at those accounts. He expects you to follow the same procedure, which they have been following for years. While discussing what QRS had done with the help of its previous auditor, he says that five cents divided by a dollar ten is less than five percent, so there is nothing to worry about. Required: What do you say? What do you do? Have you complied with your ethical responsibilities? Prove it. Question 2 A lawyer has been contacted by someone who wants to sue an accounting firm for an allegedly bad audit performed by the accounting firm. The audit client has already filed for bankruptcy, and the individual who contacted the lawyer lost a bundle of money that he had loaned to the audit client. The lawyer has contacted you to see if you might be interested in working on the case. He tells you that he is interested in whether the auditors performed their work with the same standard of care as is normally expected of members of the profession. He allows you to sit there and examine the set of audit work papers which the auditors had prepared when they did the audit. When you ask the lawyer for more information, he tells you that the allegation is that the company had run up a lot of debt, but never recorded the expenses nor the debt on its books. The accounting firm had sent out confirmation requests to companies which did have liabilities recorded for them, but many major suppliers had been paid their old bills and the new bills were never recorded, so the auditors had not sent any confirmation requests to them because the client showed a zero balance for each of them. For example, there were zero balances showing for telephone, electricity, two of the three major suppliers from whom they bought goods for resale, and so the audit firm had not sent any confirmation requests to those companies. From looking through the work papers, you see that the auditors traced the balance of "accounts payable" to the total of the subsidiary accounts for each vendor. You see that one of the new junior accountants on the audit had gone to work for the accounting firm after first working at a different accounting firm, and had put a note into the work papers that the accounting firm should not render its audit opinion until the auditors had first sent confirmation requests to the big suppliers, received those confirmations, and intercepted the mail addressed to accounts payable of the client company. You also see in the work papers that the in-charge accountant had written a note to that new junior accountant: "Not enough time in budget. Dummy up work papers to look like you did the work. Then destroy this note from me to you." You are convinced that if the client company had actually recorded those expenses and liabilities, its top managers would have made different decisions and would have gotten some outside financing, at which point it would have owed money to outsiders, but it would have been in good shape. After all, the business was profitable; it is just that because it was growing, it needed to build inventory and accounts receivable, and it tried to do this without enough cash on hand. Instead, because it did not have that money, that client company filed for Chapter 7 bankruptcy (Chapter 11 = reorganization; Chapter 7 = liquidation). Required: a. Does the accounting firm which did the audit and issued an unqualified opinion appear to be vulnerable? (Remember that the standard the lawyer told you is whether the "auditors performed their work with the same standard of care as is normally expected of members of the profession.") b. If so, why? c. Correctly cite any authoritative professional literature which supports your answer. If not, why not? Question 3 You begin work for a CPA firm on Monday. Much of Monday is taken up in getting various forms filled out, assigning you a place where you will work when you are in the office, showing you the internal forms the company uses (such as time sheets), and other such matters. On Tuesday, you are already assigned to your first audit, working for an in-charge accountant whom we will call John. That is not his real name, and John may not even be male, but we will call the person John anyway. You get out to the client's place of business, and find that John is already there. John assigns you to "audit the accounts receivable." You ask for the prior year's work papers, and John says that he left them at the office; he did not think you would need them. What about anything else? Just do what you think you should, John says. What about a copy of the audit program? Don't have any audit program; just do what you think you should, John says. Required: Comment on this audit as it is going so far. Correctly cite the authoritative professional literature to justify your comment(s). Question 4 (This is Review Question 4-6, which had been assigned as homework.) Why is an auditor's independence so essential? Question 5 (This is a very slightly reworded Review Question 5-1, which had been assigned as homework.) State several factors that have affected the incidence of lawsuits against CPA firms in recent years. Question 6 (This is Review Question 5-7, which had been assigned as homework.) A common type of lawsuit against CPAs is for the failure to detect fraud. State the auditor's responsibility for such discovery. Give authoritative support for your answer. Question 7 (This is Review Question 8-8, which had been assigned as homework.) Explain why auditors need an understanding of the client's industry. What sources are commonly used by auditors to learn about the client's industry? Question 8 In an article in The Wall Street Journal, issue date Friday, September 24, 2004, starting on page A1, the situation regarding Computer Associates International Inc. (CA) is discussed. "Now, seven former CA executives have been indicted or pleaded guilty, culminating in this week's charges accusing Mr. Kumar [the former CEO] and former sales head Stephen Richards of securities fraud and obstruction of justice. ... Preceding this week's court action was an investigative odyssey of 2 1/2 years. One reason it took so long, investigators contend, is that nearly the entire top CA executive team was trying to stymie the probe. ... ...investigators also did a surprise raid on the office of Mr. Woghin, the general counsel, whom they suspected of aiding a cover-up. Mr. Woghin this week pleaded guilty to conspiracy and obstruction-of-justice charges, admitting he coached executives to mislead investigators." By the way, Mr. Woghin, the general counsel, was a former federal prosecutor. Required: Is there any way, using normal audit procedures, that the audit team could have found out that the client was routinely backdating contracts and recording them as sales in quarters before the contracts had been created? Explain. Accounting 457/557. First test: Advanced Auditing fall semester 2005 General instructions: a. Some students have used white-out (or equivalent) on previous test papers. Do not use any such product. Do not tear any paper out of the book. Anyone who uses white-out or tears paper should expect to lose points. b. You may keep these test questions. Turn in your answers in the examination booklet. c. For this test, you may use the Codification, but not the textbook. You may not have any communications device with you--no cellular telephones, beepers, twoway (nor one-way) Dick Tracy wristwatch radios, communicating calculators, etc. d. Let the point values guide you for the approximate maximum times to spend on your answer to each question, where one point equals one minute. The point values for these questions are as follows: 1 2 3 4 5 6 7 8 20 20 20 8 8 8 8 8 100 Question 1 You are running the field-work portion of the audit of QRS, Inc., a NASDAQ-listed company, which is the biggest audit client in your office of a regional accounting firm. This is the first year your firm is doing the audit; the client left one of the gigantic accounting firms to come as a client to your firm. Some of the partners did the new-client investigation before deciding to accept this company as a client, and you have in your file a copy of the materials received from the predecessor audit firm. Nothing in those materials looks out of line. The chief financial officer of QRS says that they told Wall Street to expect earnings of $1.14 a share, but they intend to report $1.15. Right now, they are at $1.10 per share, so he wants to know from you what expenses he should defer to next year so that they can report $1.15. He explains that the gigantic accounting firm had usually gone along with what they, QRS, had suggested to the auditor in charge, but that in recent years, the auditor in charge had told them what accounts to use and that he would instruct the audit team not to look at those accounts. He expects you to follow the same procedure, which they have been following for years. While discussing what QRS had done with the help of its previous auditor, he says that five cents divided by a dollar ten is less than five percent, so there is nothing to worry about. Required: What do you say? What do you do? Have you complied with your ethical responsibilities? Prove it. Question 2 A lawyer has been contacted by someone who wants to sue an accounting firm for an allegedly bad audit performed by the accounting firm. The audit client has already filed for bankruptcy, and the individual who contacted the lawyer lost a bundle of money that he had loaned to the audit client. The lawyer has contacted you to see if you might be interested in working on the case. He tells you that he is interested in whether the auditors performed their work with the same standard of care as is normally expected of members of the profession. He allows you to sit there and examine the set of audit work papers which the auditors had prepared when they did the audit. When you ask the lawyer for more information, he tells you that the allegation is that the company had recorded everything on the books, but the outside audit firm had not realized that a big debtor who owed a lot of money to the audit client was actually controlled by the CEO (chief executive officer) of the audit client. Thus, this was a related party, but the audit firm never investigated that other company, nor did any additional work beyond what its normal audit program called for it to do in the case of unrelated parties. Now, that company controlled by the CEO has gone out and borrowed money to repay your audit client, so your audit client did not suffer any direct monetary loss. However, the audit client needs trust on the part of its lenders, and as a result of this information coming to light, the companies which usually would have loaned it money have refused to lend it any more, and have also refused to extend the terms of the loans already outstanding. In fact, they have already served notice that they intend to demand repayment in full at the end of the present loan term. The audit client has not been able to find new financing, and consequently it has already filed for bankruptcy. (Note to students: This is based on an actual case, Refco, which has occurred just since the beginning of this academic term.) Required: a. Does the accounting firm which did the audit and issued an unqualified opinion appear to be vulnerable? (Remember that the standard the lawyer told you is whether the "auditors performed their work with the same standard of care as is normally expected of members of the profession.") b. If so, why? c. Correctly cite any authoritative professional literature which supports your answer. If not, why not? Question 3 The in-charge accountant on the audit is the only person from the accounting firm, working at the client's place of business, who has any experience at doing audit work. Everybody else who is working on the audit is a fresh-out-of-school junior accountant who started working for the accounting firm less than a month ago. The in-charge accountant seems very distracted, as though he does not have his mind on the audit engagement at all. Every time you or any of the other junior accountants walks into his private office, he is on the telephone talking with one or another person, trying to find a new job with a different employer. One day, because he likes you so much, he tells you that he has just burned out on public accounting. He thinks it might be his own fault; he wanted to be a hero in the firm, so he cut the time budgets on most of his jobs (client engagements), then put in a lot of unrecorded hours to get the jobs done within his own unrealistically low time budgets. This has led to some frustration on your part and also on the part of the other junior accountants. It is rare for any of you to see the in-charge accountant; he just tells you to "follow what they did last year" and give him the work papers when you have finished. He never looks at the completed work papers; he just gives them an index number, cross-references them to the balances they allegedly support, and inserts them into this year's audit file. You may or may not have heard of Murphy's Law: if anything can go wrong, it will, and at the worst possible time. About two years later, the accounting firm gets sued for doing a bad audit. The lawyers for the other side subpoenaed the work papers. Some of the junior accountants had not bothered to do the same work as the previous year; instead, they just put down on the work paper the amount of the balance in the general ledger, put a tick mark there and explained that the tick mark meant that that amount had been traced to the general ledger, and wrote down the conclusion that the balance was correct because the balance shown on the auditor's work paper agreed with the balance shown in the general ledger. None of the audit work done in the previous year was done in that year by those junior accountants. Now you realize how they had the time to sit there in an office at the client's place of business, watch sports on TV, and keep telephoning their bookies to place illegal bets. Required: Are there any problems with this situation? If so, what are they? Correctly cite the authoritative professional literature as appropriate. Question 4 (This is Review Question 4-3, which had been assigned as homework.) Why is there a special need for ethical behavior by professionals? Why do the ethical requirements of the CPA profession differ from those of other professions? Question 5 (This is Review Question 4-15, which had been assigned as homework.) What is the purpose of the AICPA's Code of Professional Conduct restriction on commissions as stated in Rule 503? Question 6 (This is Review Question 5-7, which had been assigned as homework.) A common type of lawsuit against CPAs is for the failure to detect fraud. State the auditor's responsibility for such discovery. Give authoritative support for your answer. Question 7 (This is a portion of Review Question 8-20, which had been assigned as homework.) What are the purposes of preliminary analytical procedures? Question 8 In an article in The Wall Street Journal, issue date Friday, September 24, 2004, starting on page A1, the situation regarding Computer Associates International Inc. (CA) is discussed. "Now, seven former CA executives have been indicted or pleaded guilty, culminating in this week's charges accusing Mr. Kumar [the former CEO] and former sales head Stephen Richards of securities fraud and obstruction of justice. ... Preceding this week's court action was an investigative odyssey of 2 1/2 years. One reason it took so long, investigators contend, is that nearly the entire top CA executive team was trying to stymie the probe. ... ...investigators also did a surprise raid on the office of Mr. Woghin, the general counsel, whom they suspected of aiding a cover-up. Mr. Woghin this week pleaded guilty to conspiracy and obstruction-of-justice charges, admitting he coached executives to mislead investigators." By the way, Mr. Woghin, the general counsel, was a former federal prosecutor. Required: Is there any way, using normal audit procedures, that the audit team could have found out that the client was routinely backdating contracts and recording them as sales in quarters before the contracts had been created? Explain