1. For each of the following independent situations (a â k),describe the most appropriate course of action that the auditorsshould take.
A. While reviewing audit documentation, Tyson Michaels, apartner at K&O was reviewing working papers as part of thefirmâs system of quality control. Tyson noted that after releasingan audit report related to the financial statements of a publiclytraded client, it does not appear that any tests were conducted toevaluate the need for impairment of the carrying value of theCompany's property, plant, and equipment. These tests are importantwith respect to supporting the audit opinion.
B. Prior to the audit completion date (April 1, 2015), anauditor learned that their audit client Bubbagump Inc., haddeclared a significant dividend payable to its shareholders. Thisdividend was declared on March 14, 2015, to be paid to Bubbagumpâsshareholders of record on May 16, 2015.
C. Pat Colt completed the December 31, 2014, audit of Manningand issued an unmodified opinion on Manning's financial statementsdated March 15, 2015. Colt's opinion was released, along withManning's financial statements, on March 21, 2015. During a reviewof Manning's first quarter 10-Q in late April, Colt became aware ofthe company's settlement with a customer over a product warrantylawsuit; this case had been settled on March 17, 2015. AlthoughColt had received the necessary letter from Manning's attorneys,the letter arrived prior to the settlement of the case and did notmention this development. After reviewing the information relatedto the settlement, Colt does not believe that the settlement ismaterial to Manning's financial condition or results of operationsand believes the opinion on Manning's financial statements is stillsupportable.
D. During a PCAOB inspection, it was determined that WKRP, LLPhad not adequately documented their rationale for not observing thephysical inventory count in its audit of King Manufacturing. Thisdiscovery occurred over a full year after the audit report releasedate. Lebron McWhiney, the lead engagement partner conceded thatthe inventory observation had not occurred and alternativeprocedures were not available due to the clientâs accounting recordretention policies. In discussions with the PCAOB investigatorsLebron noted that the rationale, although not documented, was thatKingâs year-end inventory is quantitatively immaterial, at just 1%of total assets.
E. Drew Allison is conducting the audit of Anderson Inc. as ofDecember 31, 2014. At the beginning of the evidence gathering,Allison becomes aware that one of Anderson's major customers(Jones) is experiencing significant financial difficulties. Jonesnormally accounts for 5 percent of Anderson's net sales. Afterperforming the necessary procedures, Allison believes that $2.8million of Jones's receivable balance will ultimately becomeuncollectible. Allison further believes this amount is material toAnderson's financial condition and results of operations.
F. Charles Carmelo is completing the December 31, 2014, audit ofNugget Company. As part of the final procedures, Carmelo hasrequested representations from Nugget's management regarding theirassertion as to the fairness of the financial statements and otherimportant matters addressed by professional standards on February5. Because Nugget's management is attending an analyst briefing inthe upcoming week, Carmelo receives these signed representationsdated February 9, 2015. Because Carmelo had already completed allof the important procedures he released his auditorâs report, datedFebruary 5, 2015, with the financial statements on February 6.
G. Gruden LLP, was auditing Raider Company for the year endedDecember 31, 2014. Gruden plans on completing the audit by February17, 2015. On January 17, 2015, Gruden LLP learned that RaiderCompany activated a portion of its line of credit on January 5,2015, by borrowing $2.5 million. This additional obligationincreased Raider Company's long-term liabilities by 10 percent.
H. Cameron Alta completed the December 31, 2014, audit of SaxeCompany on February 10, 2015. Saxe is planning to release itsfinancial statements, along with Alta's opinion on these financialstatements and internal control over financial reporting, onFebruary 17, 2015. On February 12, 2015, a flood in one of Saxe'swarehouses located in the Gulf Coast region destroyed more than $10million of inventory. The extent to which this loss is recoverablethrough Saxe's insurance is unlikely, Alta believes that this losscould have a material impact on Saxe's financial condition andresults of operations.
I. During the audit of Glomco, Angel Myron identified a numberof misstatements. These misstatements are not material in dollaramount, do not appear to represent any discernable pattern, and donot represent fraudulent activity. As a result, Myron has decidedthat Glomco's financial statements do not need to be adjusted toreflect the effect of these misstatements.
J. Crismus and Stori, LLP is auditing Frozen Pole Desserts (FPD)for the year ended December 31, 2014. On February 9, 2015, theaudit partner in-charge Ralphy, learned of the following eventsduring his meeting with FPD's chief operating officer. A classaction lawsuit was brought against FPD by some of its formeremployees for workplace discrimination. An attorney on behalf of aclass of employees filed the lawsuit on January 10, 2015. Theletter from FPD's attorneys suggested that the amounts are notestimable and the likelihood of a negative outcome cannot bedetermined at this time.
K. Following the completion of the 2014 audit (including therelease of the audit report) of Blankenship Corporation, bySeeanSee, Muzik, and Fakdurry, LLC (SMF). Reese Jill, SMFâs auditpartner met with the manager on the audit engagement to conduct apostmortem on the engagement and identify how changes inBlankenship's operations noted during the most recent audit mayaffect future audits. During this review, Jill became aware thatBlankenship's process for evaluating potential impairment ofgoodwill related to an acquisition made by Blankenship during themost recent year had been considered and calculated by the auditteam, but for unknown reasons the adjustment had not been proposedto the client. Thus, the impairment had not been properly disclosedor accounted for in the financial statements. Jill believes thatthe results of the procedure is important in supporting the opinionon Blankenship's financial statements and notes that Blankenshipâsmanagement would probably be receptive to adjusting thefinancials.
Required: Unless otherwise noted, assume that each scenarioaffect (are material) to the Companyâs financial statements, andthere are persons who continue to rely on the financial statements.For each of the preceding items, determine:
I. whether the event described should be classified as:
A. Subsequent Event
B. Subsequently Discovered Event
C. Omitted Procedure
D. None of the above
II. what actions the auditor should take after the firm'squality review identified these issues:
1) Disclosure in financial statements
2) Adjustment to and/or disclosure in the financialstatements
3) No further action is necessary (specific auditprocedures)
4) Determine if alternative procedures are available, if so takeaction 5, if procedures are not available, withdraw the auditorâsreport
5) Perform procedures related to the item and revise theauditorâs report date if necessary
6) Perform procedures related to the items and if facts wouldresult in revision of auditorsâ report or financials, then notifyindividuals relying on financials and issue revised financialswhich provide disclosure of facts
7) Not applicable
1. For each of the following independent situations (a â k),describe the most appropriate course of action that the auditorsshould take.
A. While reviewing audit documentation, Tyson Michaels, apartner at K&O was reviewing working papers as part of thefirmâs system of quality control. Tyson noted that after releasingan audit report related to the financial statements of a publiclytraded client, it does not appear that any tests were conducted toevaluate the need for impairment of the carrying value of theCompany's property, plant, and equipment. These tests are importantwith respect to supporting the audit opinion.
B. Prior to the audit completion date (April 1, 2015), anauditor learned that their audit client Bubbagump Inc., haddeclared a significant dividend payable to its shareholders. Thisdividend was declared on March 14, 2015, to be paid to Bubbagumpâsshareholders of record on May 16, 2015.
C. Pat Colt completed the December 31, 2014, audit of Manningand issued an unmodified opinion on Manning's financial statementsdated March 15, 2015. Colt's opinion was released, along withManning's financial statements, on March 21, 2015. During a reviewof Manning's first quarter 10-Q in late April, Colt became aware ofthe company's settlement with a customer over a product warrantylawsuit; this case had been settled on March 17, 2015. AlthoughColt had received the necessary letter from Manning's attorneys,the letter arrived prior to the settlement of the case and did notmention this development. After reviewing the information relatedto the settlement, Colt does not believe that the settlement ismaterial to Manning's financial condition or results of operationsand believes the opinion on Manning's financial statements is stillsupportable.
D. During a PCAOB inspection, it was determined that WKRP, LLPhad not adequately documented their rationale for not observing thephysical inventory count in its audit of King Manufacturing. Thisdiscovery occurred over a full year after the audit report releasedate. Lebron McWhiney, the lead engagement partner conceded thatthe inventory observation had not occurred and alternativeprocedures were not available due to the clientâs accounting recordretention policies. In discussions with the PCAOB investigatorsLebron noted that the rationale, although not documented, was thatKingâs year-end inventory is quantitatively immaterial, at just 1%of total assets.
E. Drew Allison is conducting the audit of Anderson Inc. as ofDecember 31, 2014. At the beginning of the evidence gathering,Allison becomes aware that one of Anderson's major customers(Jones) is experiencing significant financial difficulties. Jonesnormally accounts for 5 percent of Anderson's net sales. Afterperforming the necessary procedures, Allison believes that $2.8million of Jones's receivable balance will ultimately becomeuncollectible. Allison further believes this amount is material toAnderson's financial condition and results of operations.
F. Charles Carmelo is completing the December 31, 2014, audit ofNugget Company. As part of the final procedures, Carmelo hasrequested representations from Nugget's management regarding theirassertion as to the fairness of the financial statements and otherimportant matters addressed by professional standards on February5. Because Nugget's management is attending an analyst briefing inthe upcoming week, Carmelo receives these signed representationsdated February 9, 2015. Because Carmelo had already completed allof the important procedures he released his auditorâs report, datedFebruary 5, 2015, with the financial statements on February 6.
G. Gruden LLP, was auditing Raider Company for the year endedDecember 31, 2014. Gruden plans on completing the audit by February17, 2015. On January 17, 2015, Gruden LLP learned that RaiderCompany activated a portion of its line of credit on January 5,2015, by borrowing $2.5 million. This additional obligationincreased Raider Company's long-term liabilities by 10 percent.
H. Cameron Alta completed the December 31, 2014, audit of SaxeCompany on February 10, 2015. Saxe is planning to release itsfinancial statements, along with Alta's opinion on these financialstatements and internal control over financial reporting, onFebruary 17, 2015. On February 12, 2015, a flood in one of Saxe'swarehouses located in the Gulf Coast region destroyed more than $10million of inventory. The extent to which this loss is recoverablethrough Saxe's insurance is unlikely, Alta believes that this losscould have a material impact on Saxe's financial condition andresults of operations.
I. During the audit of Glomco, Angel Myron identified a numberof misstatements. These misstatements are not material in dollaramount, do not appear to represent any discernable pattern, and donot represent fraudulent activity. As a result, Myron has decidedthat Glomco's financial statements do not need to be adjusted toreflect the effect of these misstatements.
J. Crismus and Stori, LLP is auditing Frozen Pole Desserts (FPD)for the year ended December 31, 2014. On February 9, 2015, theaudit partner in-charge Ralphy, learned of the following eventsduring his meeting with FPD's chief operating officer. A classaction lawsuit was brought against FPD by some of its formeremployees for workplace discrimination. An attorney on behalf of aclass of employees filed the lawsuit on January 10, 2015. Theletter from FPD's attorneys suggested that the amounts are notestimable and the likelihood of a negative outcome cannot bedetermined at this time.
K. Following the completion of the 2014 audit (including therelease of the audit report) of Blankenship Corporation, bySeeanSee, Muzik, and Fakdurry, LLC (SMF). Reese Jill, SMFâs auditpartner met with the manager on the audit engagement to conduct apostmortem on the engagement and identify how changes inBlankenship's operations noted during the most recent audit mayaffect future audits. During this review, Jill became aware thatBlankenship's process for evaluating potential impairment ofgoodwill related to an acquisition made by Blankenship during themost recent year had been considered and calculated by the auditteam, but for unknown reasons the adjustment had not been proposedto the client. Thus, the impairment had not been properly disclosedor accounted for in the financial statements. Jill believes thatthe results of the procedure is important in supporting the opinionon Blankenship's financial statements and notes that Blankenshipâsmanagement would probably be receptive to adjusting thefinancials.
Required: Unless otherwise noted, assume that each scenarioaffect (are material) to the Companyâs financial statements, andthere are persons who continue to rely on the financial statements.For each of the preceding items, determine:
I. whether the event described should be classified as:
A. Subsequent Event
B. Subsequently Discovered Event
C. Omitted Procedure
D. None of the above
II. what actions the auditor should take after the firm'squality review identified these issues:
1) Disclosure in financial statements
2) Adjustment to and/or disclosure in the financialstatements
3) No further action is necessary (specific auditprocedures)
4) Determine if alternative procedures are available, if so takeaction 5, if procedures are not available, withdraw the auditorâsreport
5) Perform procedures related to the item and revise theauditorâs report date if necessary
6) Perform procedures related to the items and if facts wouldresult in revision of auditorsâ report or financials, then notifyindividuals relying on financials and issue revised financialswhich provide disclosure of facts
7) Not applicable
