Expert Answers

19-27
(Litigation, Claims, and assessments)
During an audit engagement, an auditor is expected to communicate with lawyers concerning litigation, claims, and assessments. Listen below are five situations regarding LCA. The last clause or sentence of each states a conclusion.
1. If the client’s lawyer is silent on certain aspects of an attorney’s letter request, the auditor may infer the response is complete.
2. Letters of audit inquiry ask for the lawyer’s evaluation of the probable outcome of matters reported in the response. If the lawyer’s response does not contain this evaluation, the auditor should conclude the scope of the audit has been restricted.
3. The Top Dollar Corporation is involved in litigation for which the potential liability is so great that an unfavorable judgement at or near the claimed amount would seriously impair its operations. This is how the company’s attorneys answered the legal confirmation request: “Although no assurance can be given as to the outcome of this action, based on the facts known by us to date, in the confidence of the attorney/ client relationship and otherwise, and our understanding of the present law, we believe the company has good meritorious defense to the claims asserted against it and should prevail.” On this basis, the independent auditor may issue an unqualified opinion.
4. In situations where the auditor has orally discussed matters involving litigation with the client’s legal counsel and obtained his oral opinion on the outcome of disputed matters, it is not necessary to obtain written confirmation of these oral opinions if the auditor has summarized the attorneys’s opinion in a memo to the working papers.
5. For the past 10 years, XYZ Company has used the services of JJH&I for its primary legal advice and in many significant matters of litigation. Ninety-five percent of JJH&I’s was handling litigation involving great potential liability to the company and has now responded to the auditor’s letter of inquiry. If we assume full disclosure, complete reliance can be placed on this response.
Required
For each case, indicate whether you agree or disagree with the conclusion and the reason(s) therefor.

20-22
(Web Trust) One of your clients, Green Golf, Inc., is a retailer of golf equipment. Over the last five years 50% of the company’s business, and most of the company’s growth, have come from a shift from retail store sales to catalogue sales. The company has established a web site for business-to customer transactions, yet the customer response has reached only about 30% of projected sales. You are aware of your client’s frustrations in carving out and electronic commerce market presence, and you and your audit manager have arranged a lunch with the client to discuss Web Trust.
Required
a. Describe how a Web Trust engagement might benefit your client in his efforts to expand his use of electronic commerce in the business-to-consumer environment.
b. What assurance must your client be prepared to offer the consumer as part of a Wb-trust engagement?
c. If your client is making a statement to the public about his electronic commerce practices, why does he need a report from his CPA’s about those practices?
d. Describe the inherent limitations involved in a WebTrust engagement.

 

20-26
(Situations involving unaudited, compiled, or reviewed financial statements)
The limitations of the CPA’s professional responsibilities when he or she is associated with unaudited financial statements are often misunderstood. These misunderstandings can be substantially reduced by carefully following professional pronouncements in the course of the work and taking other appropriate measures.
Required
The following list describes seven situations the CPA may encounter or contentions he or she may have to deal with in the association with and preparation of unaudited financial statements. Briefly discuss the extent of the CPA’s responsibilities and, if appropriate, the actions that should be taken to minimize any misunderstandings. Number your answers to correspond with the numbering in the following list.
1. The CPA was engaged by telephone to perform write-up work including the preparation of financial statements. The client believes that the CPA has been engaged to audit the financial statements.
2. A group of businessmen who own a farm that is managed by an independent agent engage a CPA to prepare quarterly unaudited financial statements for them. The CPA prepares the financial statements from information given by the independent agent. Subsequently, the businessmen find the statements were inaccurate because their independent agent was embezzling funds. The businessmen refuse to pay the CPA’s fee and blame the CPA for allowing the situation to go undetected, contending that the CPA should not have relied on representations from the independent agent
3. In comparing the trial balance with the general ledger, the CPA finds an account labeled “audit fees” in which the client has accumulated the CPA’s quarterly billings for accounting services, including the preparation of quarterly unaudited financial statements.
4. Unaudited financial statements were accompanied by the following letter of transmittal from the CPA: We are enclosing your company’s balance sheet as of June 30, 20X0, and the related statements of income and retained earnings and cash flows for the six months then ended that we have reviewed
5. TO determine appropriate account classification, the CPA reviewd a number of the clients invoices. The CPA noted in the working papers that some invoices were missing but did nothing further because the CPA felt they did not affect the unaudited financial statements he or she was preparing. When the client subsequently discovered that invoices were missing, the client contended that the CPA should not have ignored the missing invoices when preparing the financial statements and had a responsibility to at least inform the client that they were missing.
6. The CPA has prepared a draft of unaudited financial statements prepared by the client’s records. While reviewing this draft the client, the CPA learns that the land and buiding were recorded at appraisal value.
7. The CPA is engaged to review, but not audit, the financial statements prepared by the client’s controller. During this review, the CPA learns of several items that by Generally Accepted Accounting Principles would require adjustment of the statements and footnote disclosures. The controller agrees to make the recommended adjustments to the statements but says that he or she is not going to add the footnotes because the statements are unaudited.
AICPA
21-24
(Operational Auditing) Enclosure Products, a large, nationwide organization, manufactures and markets several lines of equipment used in packaging. Product reliability and customer service are considered critical to the company’s success. The Customer Service Department is charged with the following responsibilities:
-Providing prospective customers with product information.
-Monitoring the adequacy of spare parts availability.
-Providing information to customers about equipment operation and maintenance.
-Preparing and providing customers training courses.
-Providing backup service and support in the event of critical breakdowns.
-Handling warranty claims.
-Maintaining general liaison with customers.
The company recently computerized its Customer Service Department to improve operational efficiency and customer satisfaction. This change represents a sizable investment by Enclosure Products. The new system includes management information to monitor performance in the areas listed above. The Audit Committee of Enclosure Products’ board of directors has requested that the internal Audit Department perform an operational audit of the Customer Service Department. The Audit Committee has asked that the audit objectives include evaluation of the following:
-Security of assets, including computer information.
-Compliance with applicable laws and company policies.
-Reliability of financial records.
-Effectiveness of performing assigned responsibilities.
-Determination of the value of the spare parts inventory.
Required
a. Explain why each of the five audit objectives suggested by the Audit Committee is, or is not, appropriate for an operational audit of Enclosure Products’ Customers Service Department.
b. Outline the basic procedures for performing an operational audit.