1-32 How does an audit enhance the quality of financial statements and management’s reports on internal control?
A financial statement audit is a systematic process of objectively obtaining and evaluating evidence regarding assertion about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria: and communicating the results to the interested parties. Managers create the financial statements and design internal control systems, the objective of external auditing is to provide a professional opinion on the reliability of the financial statements and provide opinions on internal control effectiveness. (Chapter 1, p. 3).
Does an audit guarantee a fair presentation of a company’s financial statements?
An opinion is not a guarantee of an outcome, but rather a statement of professional judgement. The auditor cannot obtain absolute assurance that financial statements are free from material misstatement because of the inherent limitations of an audit. These are caused by a number of factors. For example, many financial statement items involve subjective decisions or a degree of uncertainty (e.g., accounting estimates). Consequently, such items are subject to an inherent level of uncertainty which cannot be eliminated by the application of auditing procedures.
Retrieved September 24, 2015 from http://download.pwc.com/ie/pubs/2014-pwc-ireland-understanding-financial-statement-audit.pdf
1-33 Why is it important that users perceive auditors to be independent?
Independence requires objectivity and freedom from bias and is often referred to as the cornerstone of the auditing profession. (Chapter 1, p. 7).
Without independence, audits would lack value. Independence is a state of mind in which the auditor is unbiased and is a person of integrity, and that the auditor is a virtuous person, holding himself to the highest standards of the profession. This type of independence has a great impact on the quality of the audit performed. Independence in appearance is the perception of the public that the auditor is independent. It is achieved by following rules designed to demonstrate formal independence of the auditor from the client, and avoiding any facts or circumstances that may lead a member of the public to conclude that the auditor is biased, or lacks integrity. These rules include the code of conduct, but also various local legislations and guidelines.
Retrieved September 25, 2015 from http://www.academia.edu/3616642/A_proposal_to_increase_auditor_independence_in_fact_and_in_appearance
1-36 McIver’s Swimwear Distributors
a. Explain why management might want an independent audit of its financial statements?
An independent audit provides assurance to investors and other outsiders (ex. Lenders, banks, etc.) that the financial statements are reliable. The audit can enable the company in reviewing performance, make operational decisions, and report results to capital markets, evaluate loan decisions, considering interest rates, terms, and risk, determine taxable income and tax due, access the financial position of the company, assess credit risk. (Chapter 1, p. 7).
b. What are the factors that McIver’s might consider in deciding whether to seek an audit from a large national audit firm, a regional firm, or a local firm?
Does the firm have a good reputation, is it competent, reliable and does it follow due professional care, do they follow ethical standards, and the fees associated in performing the audit. Since McIver’s is considering a takeover or a merger with another swimwear distribution that operates in the same region, they have to take into consideration that the auditors should be familiar to this type of industry, with takeovers, mergers, and the possibility of expanding the operations into broader regions or possibly going national.
c. What type of users might be interested in McIver’s financial results?
Banks, investors, stockholders, creditors, and management.
2-28 What is a Ponzi scheme?
A Ponzi scheme occurs when the deposits of current investors are used to pay returns on the deposits of previous investors; no real investment is happening.
Describe the key elements of the Bernie Madoff fraud.
The trust comes from building a relationship with the potential victims, the greed comes form from the investors who see an opportunity to obtain higher than usual returns, and because the trust is there, they do not perform the normal due diligence, the scheme defrauded thousands of investors of billions of dollars, the amount missing from the client account’s, including fabricated gains, was almost $65 billion, Madoff built a veil of trust by running a legitimate brokerage firm and took advantage of his unique ties to the investment community to encourage further investment, Madoff conducted the scheme by keeping all of the transactions off his formal books, he employed a CPA firm to audit the books, however, a real audit was never performed, and during the time of the fraud, the PCAOB did not require that hedge funds like Madoff’s be audited by audit firms registered with the PCAOB. (Chapter 2, p. 43).
Is this fraud primarily a case of asset misappropriation or fraudulent financial reporting?
The fraud is a case of asset misappropriation of the financial statements, which initially lead to intentional manipulation of reported financial results to misstate the economic condition of the organizations committing fraudulent financial reporting. (Chapter 2, p. 42).
2-32 Identity factors (red flags) that would be strong indicators of opportunities to commit fraud?
Opportunities to commit fraud: significant related-party transactions, a company’s industry position, such as the ability to dictate individuals to structure fraudulent transactions, management’s inconsistency involving subjective judgments regarding assets or accounting estimates, simple transactions that are made complex through an unusual recording process, complex or difficult-to-understand transactions, such as derivatives or special-purpose entities, ineffective monitoring o management by the board, either because the board of directors is not independent or effective, or because there is a domineering manger, complex or unstable organizational structure, and weak or nonexistent internal controls, especially a lack of segregation of duties. (Chapter 2, p. 46).
2-33 Is the ability to rationalize the fraud an important aspect to consider when analyzing a potentially fraudulent situation?
Yes rationalization is a crucial component in most frauds. It involves a person reconciling unlawful or unethical behavior, such as stealing, with the commonly accepted notions of decency and trust, and for fraudulent financial reporting, the rationalization can range for “saving the company” to personal greed. (Chapter 2, p. 46).
What are some of the common rationalizations used by fraud perpetrators?
This is a one-time thing to get us through the current crisis and survive until things get better, everybody cheats on the financial statements a little; we are just playing the same game, fraud is justified to save a family member or loved one from financial crisis, I will lose everything, no help is available from outside, this is borrowing, and I intend to pay the stolen money back at some point and something is owed by the organization because others are treated better. (Chapter 2, p. 46).
Johnstone, K., Gramling, A., & Rittenberg, L. E. (2015). Auditing: A Risk Based-Approach to Conducting a Quality Audit. Boston, MA: Cengage
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