Solution manual for lakeside company case studies in auditing 12th edition by trussel

Usually the detailed work performed by the audit senior is more sophisticated and requires the experience gained by someone holding that rank.. SUGGESTED ANSWERS TO EXERCISE 1 The questi

The Lakeside Company:

Auditing Cases SOLUTIONS MANUAL 12e

Table of Contents

John M Trussel and J Douglas Frazer

A Note on Ethics, Fraud and SOX Questions

2

A Note on Research Assignments

3

Introductory Case

5

A NOTE ON ETHICS, FRAUD, AND SOX QUESTIONS

The Lakeside Company: Auditing Cases, 12th edition, has been updated

in light of the accounting scandals of the early 2000s, the passage of the Sarbanes-Oxley Act of 2002, and the renewed interest in ethics within the accounting and auditing profession

Sarbanes-Oxley issues have been incorporated in two ways First, case content has been altered to include Lakeside’s consideration of financing expansion through an initial public offering, and the resulting impact such a decision would have on Lakeside and on Abernathy and Chapman, CPAs Second, the discussion questions and exercises have been expanded to include consideration of Sarbanes-Oxley and new auditing and independence standards, both by adding a section in the end-of-chapter material and by reference in the other questions where appropriate

Ethics questions are now specifically identified with an ethics logo The ethics questions are often open ended, and this solutions manual does not try to give exact answers to these questions Rather, we intend to give some ideas for classroom discussion, and to help with student research on these questions

Fraud questions are now specifically identified with a fraud triangle

Fra

ud

Fra

ud

A NOTE ON RESEARCH ASSIGNMENTS

The "Apply Your Research" and "Consulting Partner Review" assignments included at the end of several cases do not lend themselves to definitive solutions that could be included in an instructor's manual The assignments are simply not intended to be exercises in arriving at a predetermined answer Rather, the applications of the suggested readings have the following objectives:

- To provide a means for improving the writing skills of students From all

reports, accounting majors too often leave college lacking in the basic ability to compose and construct sentences and paragraphs Accounting and auditing (especially as one moves up in an organization) obviously require skills other than the purely quantitative Memos, reports, footnotes, audit and accounting guides, etc., all require accountants and auditors to be effective communicators of the written word Indeed, the instructor may want to team up with a member of the school's English or communications department to enhance the effectiveness of these assignments The auditing instructor can then evaluate the technical and research portions of the assignment, while the English instructor would make suggestions as to grammar, syntax, construction of sentences and paragraphs, logic of the thought process, etc As a preliminary step, the instructor may want to assign articles such as "Word Crunching: A Primer

for Accountants" from the March 1990 issue of the Journal of

Accountancy.

- To introduce students to accounting and business journals as well as other

important publications After college, students must be able to "keep current" or their effectiveness will quickly decline In most cases, this continuation of their education is provided by the regular reading of

publications such as The Wall Street Journal, Journal of Accountancy,

CPA Journal, and Forbes These assignments require the students to

begin reading these journals prior to graduation The students should become comfortable with their ability to understand and use the materials

in professional publications In addition, real-world aspects of many accounting issues are presented through these various readings

- To develop the students' ability to derive viable solutions to auditing

problems Unfortunately, students in college often come to the belief that all auditing issues can be resolved simply by applying the pronouncements of various authoritative bodies Textbooks too often present problems that have one ultimate answer However, in many real cases, no definitive solutions actually exist Thus, when faced with such problems, students must be capable of reviewing the available literature and then using that information as a basis for arriving at a workable

- To promote auditing research In most of these library assignments, students are provided with one or more resources as starting points for their research However, the instructor should always push the students to look for more and different types of information The ultimate purpose of these assignments is to force the students into the library and online sources to do the searching for themselves One excellent method of introducing the assignments is to use some class time to illustrate the various methods of research that are available to them, including electronic resources, such as the following:

o Your state society of CPAs also operates sites

If possible, a business librarian or a research librarian may be enlisted to discuss the various search techniques that can be used at the school's library for research purposes Developing the ability to find information is one of the most important skills that can be achieved by an accounting major

INTRODUCTORY CASE

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

(1)

The staff auditor performs many of the detailed audit procedures, such as preparing and controlling accounts receivable confirmations In general the work

of the staff auditor is controlled by the audit program and supervised by the senior auditor

The senior auditor coordinates the audit at the client's location and performs many of the more difficult audit procedures, such as analytical review procedures Usually the detailed work performed by the audit senior is more sophisticated and requires the experience gained by someone holding that rank The audit senior is supervised by the manager

The manager and the partner have supervisory roles Managers and partners often have more than one audit team under supervision at any given time

The partner is the person who has responsibility for determining whether the firm’s signature can be attached to audit report

(2)

The partner-in-charge of an audit is the definitive decision-making position on the audit team Although the manager and senior auditor make several decisions, they must get ultimate approval from the partner-in-charge of the audit The consulting partner's role is to add a further degree of objectivity to the audit The consulting partner reviews and critiques certain crucial decisions made by the audit team, such as the final audit report The partners should be rotated to assure independence

Sarbanes-Oxley (SOX-S203) requires the identification of a Leading Partner and

a Reviewing Partner Both partners must be rotated every five years

(3)

An accounting firm is a business like any other, and its management must recognize that a marketing strategy is probably necessary to generate a continual flow of sufficient operating revenues However, in the accounting profession, disagreement exists as to the extent that such marketing should take

In the past, overt marketing was not permitted since it was considered to be unprofessional This position was supported based on the reasoning that a firm

should be selected based solely on the quality of its service No reliable system existed, though, for conveying such information to potential clients Hence, firms with many clients tended to remain large, while smaller firms often found growth

to be nearly impossible In the free market system espoused by the United States, restrictions on such practices as advertising and solicitation were inevitably overturned Over the past three decades, attitudes toward marketing have changed dramatically as competition has become much more intense Advertisements by CPA firms in newspapers and magazines are now common Newsletters such as that distributed by Abernethy and Chapman are also frequently used to increase a firm's name recognition in the business community

In the current world of business, some type of marketing strategy seems imperative if an accounting firm is to compete Whether that marketing should extend to formal advertising is often a question of firm policy Most importantly, the firm must ensure that potential clients know of its presence and the services that it offers A client will probably not select a CPA firm based on advertising However, the client may initially become aware of the firm only through some type of marketing

Interestingly, some members of the accounting profession view marketing as having had a negative impact on the profession as a whole Price competition for new clients is often associated with the marketing of a firm These critics assert that lowered fees result in sloppy and hurried audit work that can decrease the overall reputation of the profession (Additional resources discussing this issue can be found in the "Suggested Readings" at the end of this case.)

(4)

A national or international CPA firm might consider acquiring Abernethy and Chapman for several reasons:

- Although only a regional firm, Abernethy and Chapman apparently has a

client base that includes a number of large clients in several different industries By acquiring the local firm, the larger organization will frequently be able to retain these customers, thus increasing its own client list

- The larger firm may be interested in moving into this geographical region,

and buying the local firm will provide an instant base on which to build a practice in the area

- The larger firm may already have an office in this location and feels that

combining the practices will reduce expenses

Abernethy and Chapman might have several reasons for viewing an acquisition

in a favorable light:

- Frequently, the purchase price will be a considerable amount of money

because of the goodwill inherent in an established accounting firm The offer to sell may be especially tempting if the partners are nearing retirement age and the future of the firm appears uncertain

- The smaller firm may have trouble dealing with increased competition from

bigger firms Often clients may decide that a change to a nationally known CPA firm should be made to add extra stature to the audit report If a local organization has only a few large clients, it cannot economically afford to lose a significant amount of revenue in this way A merger may help the firm to keep its clients

- The regional firm may also desire the additional backup services offered by large organizations National CPA firms usually have experts in many industries as well as in specific audit areas who are available for consultation In a smaller firm, this degree of assistance is not always available when a difficult accounting or auditing problem is encountered

- PCAOB registration and SEC practice presents hurdles that might be overcome through a merger with a larger firm

Many mergers have occurred in the auditing profession during recent years Critics assert that this trend has reduced competition and will inevitably lead to a decrease in audit quality Proponents counter by stating that mergers lead to more efficient operations and, thus, improve audit quality Obviously, mergers will create a drastic change in the profession as more of the smaller firms disappear Audit work in this country may possibly become concentrated within the largest CPA firms Whether this result is good for the auditing profession may

be merely a question of perspective To the smaller firms struggling to survive and grow, the mergers are usually considered a threat as the bigger firms become more competitive To the larger firms, the chance for continued growth and more efficient operations is always an important objective

See the Sarbanes-Oxley section below for a follow-up question related to the impact of SOX on the auditing profession

(5)

Moving staff from one area of a CPA firm to another can cause the perception of

an independence problem For example, the appearance of independence may

be in question if a member of the consulting staff helps to install a new accounting system for a client and then she moves to the audit staff to audit this same client

See the Sarbanes-Oxley section below for a follow-up question/answer related to

the impact of SOX, in particular the list of proscribed activities for registered CPA firms

SUGGESTED ANSWERS TO EXERCISE

(1)

The question requires students to address all the elements of a quality control

system, as included in Statement on Quality Control Standards No 2 In some

cases, students should recognize the need for additional information

To: DeAnna Malott

From:

Date:

Re: Quality Control Standards at Abernethy and Chapman

Overview: I was employed by the firm of Abernethy and Chapman to review the quality control standards within the firm The following represents my evaluation of these standards according to the six elements required by the AICPA

Evaluation:

Standard Existing

Procedures

Recommendations Additional

Information Needed

Leadership

responsibilities •The case does

not explicitly address this standard

However, the firm has some items

in place, such as

a partner dedicated to monitoring the system

•The firm should have policies in place that establish the “tone at the top” for quality within the firm

•What specific policies does the firm have to demonstrate leadership responsibilities for quality within the firm?

Relevant

ethical

requirements

•Firm requires its employees to sever all financial ties to audit clients

•The AICPA's Code of

Professional Conduct does not

require all employees

to sever ties with all audit clients For example, staff auditors not working

on a particular engagement need

•The case does not mention spouses or dependents of the employees Spouses and dependents must also be

independent, as defined by

not sever ties In this case, the firm

exceeds the minimum level of conduct for independence

•The case does not address other ethical requirements

Section 100 Rule 101 of the

Code In this

case, the firm should

strengthen its requirements

•How does the firm meet other ethical

requirements? Acceptance

and

continuation of

clients

•This case does not address this control standard

It does note that the firm is

attempting to gain more clients through an extensive marketing program

•It is important to have many controls when considering a potential client, so that the potential risks of legal exposure are not too great (Note: This topic is addressed in Case 2.)

•

Human

resources

•The firm considers experience and technical

competence in assigning personnel to audit

engagements

•The firm hires only college graduates with a major in

accounting and requires that each

professional sit for the CPA exam within one year of

employment

•The firm requires

•This appears to be a reasonable quality control

•This seems to be a more than adequate quality control procedure In fact, many firms hire professionals, such

as computer experts, who were not

accounting majors

•Many states require

40 hours of continuing education per year; however, the case does not address the issue of the type

of education (e.g., accounting and auditing versus other courses)

• The firm promotion procedures consider seniority and technical competence, which seems to

be an adequate control

that a minimum number of continuing professional

education hours be

in accounting- and auditing-related courses

•The case does not address the issue of

assessment of technical competence Many firms require a written assessment of performance after each engagement

Engagement

performance •The firm requires

that a consulting partner be assigned to each audit

engagement

The consulting partner assures that the work performed by the engagement team meets applicable professional standards and regulatory requirements

This helps to ensure objectivity, as the consulting

•The firm should have

a mechanism for consultation with authoritative literature and other sources, including outside experts, if its professional staff lacks expertise in a particular area

•It is not clear from the case how the team documents the work

performed on an audit

engagement An evaluation of audit

documentation is necessary for complete evaluation of the quality controls