You are a young CPA just starting your own practice in Hollywood, California, after five years’ experience with a “Big 4” firm. You have several connections in the entertainment industry and hope to develop a practice rendering income tax, auditing, and accounting services to celebrities and other wealthy clients.
One of your first engagements is arranged by John Forbes, a long-established business manager for a number of celebrities and a personal friend of yours. You are engaged to audit the personal statement of financial condition (balance sheet) of Dallas McBain, one of Forbes’s clients.
McBain is a popular rock star, with a net worth of approximately $100 million. However, the star also has a reputation as an extreme recluse who is never seen in public except at performances. Forbes handles all of McBain’s business affairs, and all your communications with McBain are through Forbes. You have never met McBain personally and have no means of contacting the star directly. All of McBain’s business records are maintained at Forbes’s office. Forbes also issues checks for many of McBain’s personal expenses, using a check-signing machine and a facsimile plate of McBain’s signature.
During the audit, you notice that during the year numerous checks totaling approximately $500,000 have been issued payable to Cash. In addition, the proceeds of a $250,000 sale of marketable securities were never deposited in any of McBain’s bank accounts. In the accounting records, all of these amounts have been charged to the account entitled “Personal Living Expenses.” There is no further documentation of these disbursements.
When you bring these items to Forbes’s attention, he explains that celebrities such as McBain often spend a lot of cash supporting various “hangers-on,” whom they don’t want identified by name. He also states, “Off the record, some of these people also have some very expensive habits.” He points out, however, that you are auditing only the statement of assets and liabilities, not McBain’s revenue or expenses. Furthermore, the amount of these transactions is not material in relation to McBain’s net worth.
a. Discuss whether the undocumented disbursements and the missing securities’ proceeds should be of concern to you in a balance sheet–only audit.
b. Identify the various courses of action that you might at least consider under these circumstances. Explain briefly the arguments supporting each course of action.
c. Explain what you would do and justify your decision.
d. Assume that you are a long-established CPA, independently wealthy, and that the McBain account represents less than 5 percent of the annual revenue of your practice. Would this change in circumstances affect your conclusion in part (c)? Discuss.