Task 1: Case Study (Client Acceptance) An opening for partnership had just been announced in the local office of JAW & Associates (JAW), a CPA firm. The new partnership position, justified by increased revenues, was a cause for celebration among the managers aspiring to become partners in the firm. Competition mounted for the new position once the announcement was made. Matt Cooper, one of the senior audit managers, was the current favorite for admission to the partnership. Matt 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. Matt had been making himself very visible in the business community by joining local business and not-for-profit organizations and he was becoming a local leader in a respected civic organization. This activity had helped Matt identify prospective clients and, in fact, had 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. During a round of golf with the controller of a local automobile dealership, Matt asked his golf partner, Ted Carrey, 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 FS Ltd (FSL), had 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 Matt contact Eve to determine whether she was serious about switching auditors, but he warned that Eve was a tough business person with a reputation for being shrewd. Matt was so delighted with the new lead that he happily picked up the tab for golf and lunch. Matt 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. Matt noted that a reputable firm had audited FSL 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, Matt developed a tentative proposal to perform the audit of FSL 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 Matt regarding FSL. According to Matts best estimates of 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. Matt told Eve that the engagement, including the proposed audit fee, could not be finalised until he performed a more thorough background investigation of FSL and had obtained approval of the JAW partners. This investigation, required by JAW prior to acceptance of all new 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 FSL and Eve. JAW required Matt to inform the Partner in Charge of Audit, Jackie Godfrey, and to obtain a favorable vote of the local office partners prior to acceptance of the new client. The background review resulted in the following information: 1. FSL is a small 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 FSL. FSL weathered a recent business recession and still maintained net income comfortably above the average for peer financial institutions. 2. Eve has a reputation as an aggressive businessperson 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 favourable. She personally supervises collection activities on difficult loans and one collection agency owner familiar with FSL commented that there was not much opportunity left for collection after Eve got through. 3. As of the previous audit, total assets of FSL 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 FSL was related to depositor accounts, primarily CDs. 4. Matt visited the predecessor auditor and was allowed to examine and copy some of the working papers from the prior year 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, Matt 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 Matt 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 FSL. 5. Most of the loans held by FSL came from used car dealers, small home repair and remodeling contractors, and door-to-door sales people 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 sales people and small businesses willing to sell her their loans receivable. 6. Talks with the controller of FSL 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, Matt 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, CIA). 7. Matts business contacts were willing to freely discuss their experience with Eve and with FSL. They consistently depicted Eve as disciplined, aggressive, and shrewd. Within FSL she was viewed as direct, overbearing, and intolerant of error. 8. FSL 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 renegotiate the charges prior to making payment. The prior auditor had been paid within a reasonable time after completion of the engagement. Matt summarised his background review for Jackie, noting the above points. Overall, he concluded that FSL would be an acceptable audit client and recommended to Jackie that the engagement be accepted by JAW. Matt 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 Matts last opportunity to add another client prior to his evaluation for a partnership position. If Matt was not admitted to the partnership soon, he would likely be asked to leave the firm to make room for other promising candidates. Required: 1. Place yourself in the position of Jackie Godfrey. Matt has just presented the above facts to you and asked for your support in accepting the FSL audit engagement. a. With any prospective engagement, there are reasons to accept the engagement. Based on the facts of the case, prepare a list of specific factors or reasons to accept the FSL audit engagement. Briefly explain why each reason would be a positive factor in your assessment of FSL as an audit client. b. Virtually all audit engagements have warning signs that could indicate potential for future problems. Based on the facts of the case, prepare a list of specific factors or reasons not to accept the FSL audit engagement. Briefly explain why each reason would be a negative factor in your assessment of FSL as an audit client. (7 marks) 2. Assume that it is normal procedure for the accounting firm to circulate the background review of a prospective client, with an accompanying memo from the Partner in Charge of Audit, to all partners before approval of the engagement. Write a short memo from Jackie Godfrey to her fellow partners to accompany the background review. State and support a recommendation regarding acceptance or rejection of the FSL audit engagement. Be professional and make convincing arguments that will encourage fellow partners to support your recommendation. (3 marks) (Total: 10 marks) Note: You are required to provide a list of all references used for this assignment.