Week 3 Homework Questions 1) The following questions are based on the same scenario I used for question 3 in your week 1 homework. That question addressed violations of the Code of Conduct. I want to apply the same scenario to legal liabilities. Here

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Week 3 Homework Questions

 

1)             The following questions are based on the same scenario I used for question 3 in your week 1 homework.  That question addressed violations of the Code of Conduct.  I want to apply the same scenario to legal liabilities.  Here is a copy of the scenario:

John Smith owns a small, privately held firm.  He hired you to audit its financial statements.  He told you that the audit was to be completed in time to submit audited financial statements to a bank as part of a loan application.  You immediately accepted the engagement and agreed to provide an auditor's report within three weeks.  John agreed to pay you a fixed fee plus a bonus if the loan was granted.  You hired two accounting students to conduct the audit and spent several hours telling them exactly what to do.  You told the students not to spend time reviewing John's internal controls but instead to concentrate on proving the mathematical accuracy of the ledger accounts and on summarizing the data in the accounting records that support John's financial statements.  The students followed your instructions and, after two weeks, gave you the financial statements, which did not include footnotes.  You studied the statements and prepared an unqualified auditor's report.  The report, however, did not refer to generally accepted accounting principles or to the fact that John had changed to the accounting standard for capitalized interest. 

 

Here are the new questions:

 

a)              After the audit was completed, John used the financial statements to secure a loan from a bank.  Within a year, John was unable to make payments on the loan.  In the process of investigating the reason why, the bank determined that the financial statements were material misstated.  John, however, was near bankruptcy and could not pay off the loan.  The bank sued you for the balance due on the loan.  Given the violations I discussed in my solution to the week 1 homework, do you think the bank will prevail?  You answer should provide an analysis of the legal issues involved to include what basis the bank would have to sue, what you level of liability would be(proportionate or joint and several), and a clear statement of why or why not you think the bank would prevail to include how effective your defenses might be. 

 

 

 

b)             Now assume that instead of applying for a bank loan, you knew that John was planning to use the financial statements as part of a prospectus for an initial public stock offering (IPO), i.e., John's firm sold stock directly to the public.  John did and a potential investor read the prospectus and did a comprehensive analysis of the financial statements as a basis for his decision to buy a significant portion of stock in the new corporation.  A year later, the firm was doing so badly that its stock price was down to 10% of what it was after the IPO.  The investor sued both the John's new corporation and you for his investment losses.  During the trial, the investor was able to show that the financial statements were materially misstated in key areas that affect firm value.  Given the violations I discussed in my solution to the week 1 homework, do you think the investor will prevail?  You answer should provide an analysis of the legal issues involved to include what bases (cover all that apply) the investor would have to sue, what your level of liability would be (proportionate or joint and several), and a clear statement of why or why not you think the investor would prevail to include how effective your defenses might be.  

 

 

 

2)             The text lists 18 audit objectives - 8 for balances, 6 for transactions, and 4 for presentation and disclosure.  For each of the following audit procedures, list the category and specific objective each tests and provide an explanation of why you selected the category and object.  Some of these audit procedures test more than on objective and I want you to list and explain all that apply.  Assume all procedures were executed on the audit for a fiscal year ending December 31, 2014.  Fill in the following table to answer the question.  I have filled in the first item as an example.

 


Audit Procedure

Category

Objective

Explanation

1. Examine sales invoices for the last five sales transactions recorded in the sales journal in 2014 and examine shipping documents to determine they are recorded in the correct period.

Balance

 

 

 

 

 

Transaction

Cutoff

 

 

 

 

 

Timing

The cutoff object is to determine that transactions recorded near the end of an accounting period are included in the correct period.  The text is unclear here because it states that balance-related objectives are applied to balance sheet accounts and sales is an income statement account.  However, I believe the procedure still fits the cutoff objective. 

 

This procedure would also test whether the transaction was recorded on the correct date.  Since transactions that are recorded at the end of the year also are recorded during the year, this objective also would apply.

2. Add all customer balances in the accounts receivable trail balance and agree the amount to the general ledger.

 

 

 

3. Determine whether long-term receivables and related party receivables are reported separately in the financial statements. 

 

 

 

4. For a sample of shipping documents selected from shipping records, trace each shipping document to a transaction recorded in the sales journal. 

 

 

 


 

Audit Procedure

Category

Objective

Explanation

5. Determine whether all risks related to accounts receivable are adequately disclosed. 

 

 

 

6. Examine a sample of duplicate sales invoices to determine whether each one has a shipping document attached. 

 

 

 

7. Inquire of the client whether any accounts receivable balances have been pledged as collateral on long-term debt and determine whether all required information is included in the footnote description for long-term debt. 

 

 

 

8. Send letters to a sample of accounts receivable customers to verify whether they have an outstanding balance at December 31, 2014

 

 

 


 

Audit Procedure

Category

Objective

Explanation

9. For a sample of sales transactions selected from the sales journal, verify that the amount of the transaction has been recorded in the correct customer account in the accounts receivable ledger. 

 

 

 

10. Foot the sales journal for the month of July and trace posting to the general ledger.

 

 

 

11. For a sample of customer accounts receivable balances at December 31, 2014, examine subsequent cash receipts in January 2015 to determine whether the customer paid the balance due.

 

 

 

12. Discuss with the credit department personnel the likelihood of collection of all accounts as of December 31, 2014 with a balance greater than $100,000 and greater than 90 days old.

 

 

 

 

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