Problem 1 - The PCAOB has proposed changes to the auditor's report for public companies that include requirements for the auditor to communicate "critical audit matters." Critical audit matters include those matters during the audit that involved difficult, subjective, or complex auditor judgments or that posed difficulty to the auditor in obtaining sufficient appropriate evidence or in forming the opinion on the financial statements. Similarly, the International Auditing and Assurance Standards Board (IAASB) recently revised the auditor's report in the International Standards on Auditing (ISAs) to require auditors to communicate "key audit matters." Key audit matters include communication of similar kinds of information as proposed by the PCAOB such as areas of higher assessed risk of material misstatement and the effects of significant events or transactions that occurred during the period.
Required -
a. Describe how users of the financial statements may benefit from communications about these matters in an audit report.
b. Describe how communication of these matters may not be beneficial to users of the financial statements.
c. What difficulties, if any, may auditors face in communicating about these matters?
Problem 2 - Newspaper headlines frequently highlight instances where business professionals, politicians, and others are accused of engaging in unethical behavior. In response, there have been numerous attempts to reduce their occurrence. For example, some have argued for universities to include more courses in ethics.
Required -
a. Describe what constitutes "ethics" and highlight the challenges of developing a set of rules and guidance to increase ethical behavior in society.
b. Why is ethics important to the conduct of business in a market-based economy?
c. Why do individuals act unethically?
d. What are common rationalizations individuals use to justify their unethical behavior?
e. Discuss whether ethics should be taught, for example, in university courses.
Problem 3 - The following independent scenarios describe auditor behavior on an audit engagement.
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.
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.
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 that inventory, 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.
4. The audit engagement partner, Marc Johnson, recently received a subpoena for work-papers 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 work paper files documenting communication between the engagement partner and the CFO regarding the goodwill impairment analysis.
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.
Required -
For each of the scenarios listed above, discuss whether the auditor's behavior would be considered nonnegligence, ordinary negligence, gross negligence, constructive fraud, fraud, or criminal behavior.