The following independent scenarios describe auditor behavior on an audit engagement.

REQUIRED:

For each of the scenarios listed below, discuss whether the auditors behavior would be considered nonnegligence, ordinary negligence, gross negligence, constructive fraud, fraud, or criminal behavior. (Some scenarios may require multiple answers)

1. Chad Lewis is the lead audit partner on the audit engagement of a publicly traded company. Chad followed auditing standards on the audit engagement and issued an unmodified opinion. It was subsequently discovered that the financial statements contained a material misstatement that had been undetected by the management of the company and by the audit team.

Given that an audit does not provide absolute assurance, a material misstatement may still go undetected even when an adequate audit is conducted.

2. Maria Marquez, CPA, is a sole proprietor. She recently accepted a new audit client who was applying for a bank loan and needed to present audited financial statements to the bank. Maria was not able to complete the audit engagement by herself, so she hired several college students to assist her. The students completed the audit procedures without much guidance, and Maria issued an unmodified opinion on the client's financial statements.

Maria Marquez willfully violated auditing standards by hiring unqualified assistants and failing to properly supervise them, but likely did not intend to deceive the bank.

3. On a recent audit engagement, the client firm neglected to inform the audit firm that a significant percentage of inventory was stored at an outside warehouse. As a result, the auditors did not observe the physical inventory count for thatinventory, which represented 20% of the client's inventory balance. The auditors were able to satisfy themselves that the inventory existed through alternative procedures, and issued an unmodified opinion on the financial statements as a whole.

The auditors were able to satisfy themselves through alternative procedures that the inventory existed as of the end of the year.

4. The audit engagement partner, Marc Johnson, recently received a subpoena for workpapers related to an audit engagement on which his audit firm has been named as a defendant. Marc asked the staff auditor to remove and discard two memos from the workpaper files documenting communication between the engagement partner and the CFO regarding the goodwill impairment analysis.

In this scenario, there is an intent to deceive. In addition, the Sarbanes Oxley Act of 2002 made it a felony to destroy or create documents to impede or obstruct a federal investigation.

5. Melissa Louis is the lead engagement partner on a publicly traded company. The company's CEO recently approached Melissa and informed her that they had identified a material misstatement in the prior year's financial statements, which had been audited by Melissa's firm and submitted to the SEC. The CEO suggested they correct the misstatement by recording a journal entry in the current year for half of the amount of the misstatement, and in the following year for the remaining half. Melissa agreed to this plan to avoid a public announcement of a restatement and a potential lawsuit, since the amount of the journal entries recorded in the current and subsequent years would be considered immaterial to the financial statements.

Melissa Louis is knowingly deceiving investors by agreeing to hide a material misstatement.