QUESTION 1 [CLO 1] a) A competent auditor has done a conscientious job of conducting an audit, but because of a clever fraud by management, a material fraud is included in the financial statements. The fraud, which is an overstatement of inventory, took place over several years, and it covered up the fact that the company's financial position was rapidly declining. The fraud was accidently discovered in the latest audit by an unusually capable audit senior, and the SC was immediately informed. Subsequent investigation indicated that the company was near bankruptcy, and the value of the stock dropped from RM 26 per share to RM 1 in less than 1 month. Among the losing stockholders were pension funds, university endowment funds, retired couples, and widows. The individuals responsible for perpetrating the fraud were also bankrupt. After making an extensive investigation of the audit performance in previous years, the SC was satisfied that the auditor had done a high-quality audit and had followed Malaysian Approved Standards on Auditing in every aspect. The commission concluded that it would be unreasonable to expect auditors to uncover this type of fraud. Based on the above scenario, you are required to: State your opinion as to who should bare the loss of the fraudulent financial reporting. Include in your discussion a list of potential bearers of the loss, and state why you believe they should or should not bare the loss. (10 marks) b) Rene Ritter opened a small grocery and related-products convenience store in 1989 with money she had saved working as an A&P store manager. She named it Ritter Dairy and Fruits. Because of the excellent location and her fine management skills, Ritter Dairy and Fruits grew to three locations by 1994. By that time, she needed additional capital. She obtained financing through a local bank at 2 percent above prime, under the condition that she submit quarterly financial statements reviewed by a CPA firm approved by the bank. After interviewing several firms, she decided to use the firm of Gonzalez & Fineberg CPAs, after obtaining approval from the bank. FE_BAA2563 In 1998, the company had grown to six stores, and Rene developed a business plan to add another 10 stores in the next several years. Ritter's capital needs had also grown, so Rene decided to add two business partners who both had considerable capital and some expertise in convenience stores. After further discussions with the bank and continued conversations with the future business partners, she decided to have an annual audit and quarterly reviews done by Gonzalez & Fineberg, even though the additional cost was almost $25,000 annually. The bank agreed to reduce the interest rate on the $4,000,000 of loans to 1 percent above prime. By 2003, things were going smoothly, with the two business partners heavily involved in day-to-day operations and the company adding two new stores each year. The company was growing steadily and was more profitable than they had expected. By the end of 2002, one of the business partners, Fred Worm, had taken over responsibility for accounting and finance operations, as well as some marketing, Annually, Gonzalez & Fineberg did an in-depth review of the accounting system, including internal controls, and reported their conclusions and recommendations to the board of directors. Specialists in the firm provided tax and other advice. The other partner, Ben Gold. managed most of the stores and was primarily responsible for building new stores, Rene was president and managed four stores. In 2008. the three partners decided to go public to enable them to add more stores and modernize existing ones. The public offering was a major success, resulting in $25 million in new capital and nearly 1,000 shareholders. Ritter Dairy and Fruits added stores rapidly under the three managers, and the company remained highly profitable under the leadership of Ritter, Worm, and Gold Rene retired in 2011 after a highly successful career. During the retirement celebration, she thanked her business partners, employees, and customers. She also added a special thanks to the bank management for their outstanding service and to Gonzalez & Fineberg for being partners in the best and most professional sense of the word. She mentioned their integrity, commitment, high-quality service in performing their audits and reviews, and considerable tax and business advice for more than two decades. Based on the above scenario, you are required to: i. Explain why the bank imposed a requirement of a quarterly review of the financial statements as a condition of obtaining the loan at 2 percent above prime. (5 marks) ii. Explain why Ritter Dairy and Fruits agreed to have an audit performed rather than a review, considering the additional annual cost of $25,000. (10 marks) FE BAA2563 iii. What benefit does Gonzalez & Fineberg provide to stockholders, creditors, and management in performing the audit and related services? (5 marks) What are the responsibilities of the CPA firm to stockholders, creditors, management, and other users? iv. QUESTION 1 [CLO 1] a) A competent auditor has done a conscientious job of conducting an audit, but because of a clever fraud by management, a material fraud is included in the financial statements. The fraud, which is an overstatement of inventory, took place over several years, and it covered up the fact that the company's financial position was rapidly declining. The fraud was accidently discovered in the latest audit by an unusually capable audit senior, and the SC was immediately informed. Subsequent investigation indicated that the company was near bankruptcy, and the value of the stock dropped from RM 26 per share to RM 1 in less than 1 month. Among the losing stockholders were pension funds, university endowment funds, retired couples, and widows. The individuals responsible for perpetrating the fraud were also bankrupt. After making an extensive investigation of the audit performance in previous years, the SC was satisfied that the auditor had done a high-quality audit and had followed Malaysian Approved Standards on Auditing in every aspect. The commission concluded that it would be unreasonable to expect auditors to uncover this type of fraud. Based on the above scenario, you are required to: State your opinion as to who should bare the loss of the fraudulent financial reporting. Include in your discussion a list of potential bearers of the loss, and state why you believe they should or should not bare the loss. (10 marks) b) Rene Ritter opened a small grocery and related-products convenience store in 1989 with money she had saved working as an A&P store manager. She named it Ritter Dairy and Fruits. Because of the excellent location and her fine management skills, Ritter Dairy and Fruits grew to three locations by 1994. By that time, she needed additional capital. She obtained financing through a local bank at 2 percent above prime, under the condition that she submit quarterly financial statements reviewed by a CPA firm approved by the bank. After interviewing several firms, she decided to use the firm of Gonzalez & Fineberg CPAs, after obtaining approval from the bank. FE_BAA2563 In 1998, the company had grown to six stores, and Rene developed a business plan to add another 10 stores in the next several years. Ritter's capital needs had also grown, so Rene decided to add two business partners who both had considerable capital and some expertise in convenience stores. After further discussions with the bank and continued conversations with the future business partners, she decided to have an annual audit and quarterly reviews done by Gonzalez & Fineberg, even though the additional cost was almost $25,000 annually. The bank agreed to reduce the interest rate on the $4,000,000 of loans to 1 percent above prime. By 2003, things were going smoothly, with the two business partners heavily involved in day-to-day operations and the company adding two new stores each year. The company was growing steadily and was more profitable than they had expected. By the end of 2002, one of the business partners, Fred Worm, had taken over responsibility for accounting and finance operations, as well as some marketing, Annually, Gonzalez & Fineberg did an in-depth review of the accounting system, including internal controls, and reported their conclusions and recommendations to the board of directors. Specialists in the firm provided tax and other advice. The other partner, Ben Gold. managed most of the stores and was primarily responsible for building new stores, Rene was president and managed four stores. In 2008. the three partners decided to go public to enable them to add more stores and modernize existing ones. The public offering was a major success, resulting in $25 million in new capital and nearly 1,000 shareholders. Ritter Dairy and Fruits added stores rapidly under the three managers, and the company remained highly profitable under the leadership of Ritter, Worm, and Gold Rene retired in 2011 after a highly successful career. During the retirement celebration, she thanked her business partners, employees, and customers. She also added a special thanks to the bank management for their outstanding service and to Gonzalez & Fineberg for being partners in the best and most professional sense of the word. She mentioned their integrity, commitment, high-quality service in performing their audits and reviews, and considerable tax and business advice for more than two decades. Based on the above scenario, you are required to: i. Explain why the bank imposed a requirement of a quarterly review of the financial statements as a condition of obtaining the loan at 2 percent above prime. (5 marks) ii. Explain why Ritter Dairy and Fruits agreed to have an audit performed rather than a review, considering the additional annual cost of $25,000. (10 marks) FE BAA2563 iii. What benefit does Gonzalez & Fineberg provide to stockholders, creditors, and management in performing the audit and related services? (5 marks) What are the responsibilities of the CPA firm to stockholders, creditors, management, and other users? iv