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All Textbook Solutions for Auditing: A Risk Based-Approach to Conducting a Quality Audit

1TFQ 2TFQ 3TFQ 4TFQ 5TFQ 6TFQ 7TFQ 8TFQ 9TFQ 10TFQ 11TFQ 12TFQ 13TFQ 14TFQ 15MCQ 16MCQ 17MCQ 18MCQ 19MCQ 20MCQ 21MCQ 22MCQ 23MCQ 24MCQ 25MCQ 26MCQ 27MCQ Which of the following factors is an example of a risk relevant to the client continuance decision? a. Client entity characteristics. b. Independence risk factors. c. Third party/due diligence risk factors. d. All of the above.29RSCQ 30RSCQ 31RSCQ 32RSCQ 33RSCQ 34RSCQ 35RSCQ 36RSCQ 37RSCQ 38RSCQ 39RSCQ 40RSCQ 41RSCQ 42RSCQ 43RSCQ 44RSCQ 45RSCQ 46RSCQ 47RSCQ 48RSCQ 49RSCQ 50RSCQ 51RSCQ 52RSCQ 53RSCQ 54FF 55FF Enron and Arthur Andersen UP Enron was an energy comp any based in Houston, Texas, that made energy trades. It was formed in 1985 with the merger of Houston Natural Gas and lnterNorth. After an aggressive expansion plan that involved risky financing transactions outside the original, fundamental business model of the company, Enron was billions of dollars in debt. Enron concealed this debt through hidden transactions with related-party partnerships, fraudulent accounting, and illegal loans. Enron is considered to be one of the largest and most important financial reporting frauds in history. The company ultimately filed for bankruptcy in 2001. One of the reasons that Enron was able to get away with the fraud for some rime was because of a low-quality audit by its external audit firm, Arthur Andersen. Prior to the failure of Enron in 2001, Arthur Andersen had been involved in two other major audit failures. These failed audits, related to frauds at Waste Management (1996) and Sunbeam (1997), should have raised red flags for management and any outside observers that some of the audit firm’s internal quality assurance processes were not working. When the federal government uncovered Enron’s fraud along with the string of poor quality audits at Arthur Andersen, the government forced the audit firm out of business. Internal documentation at Arthur Andersen showed that there were conflicts between the auditors and the audit committee of Enron, and that even though there were many individuals concerned about the accounting and disclosure practices at Enron, nothing was done by Andersen to report these problems. In fact, the leading partner on the audit, David Duncan, actively worked to ensure that Enron’s fraudulent financial reporting went uncovered. It appears that Duncan was motivated by the fact that Arthur Andersen was earning enormous consulting fees on the Enron engagement; Enron was a hugely important client for him personally and for the Houston office of Arthur Andersen. Together, these conflicts of interest clouded his independent judgment and professional skepticism. Around the time that Enron declared bankruptcy in late 2001, Arthur Andersen personnel in the Houston office began aggressively destroying documentation relating to the Enron engagement. This action enabled the federal government to file charges against Arthur Andersen that ultimately led to the downfall of the audit firm. The Sarbanes-Oxley Act of 2002 was enacted partially in response to the Enron fraud and the revelation of the poor audit conducted by Arthur Andersen, which is why this case is of particular historical relevance. Considering these facts, answer the following questions: a. Members of Enron management were the individuals who perpetrated the financial statement fraud, this, why do you think the auditors were held responsible when they are not the ones actually making the fraudulent journal entries? b. Explain why the consulting fees and importance of Enron to David Duncan and the Houston office of Arthur Andersen might have affected Duncan’s independence, and thus the quality of the audits he supervised. c. Describe the likely users of Enron’s audited financial statements. How were these various user groups likely affected by the fraud? d. How might the sequential list of frauds perpetrated by Arthur Andersen client (Wage Management, Sunbeam, and finally Enron) have affected the decision by the SEC and federal prosecutors to aggressively seek Arthur Andersen’s legal demise?The Great Salad Oil Swindle of 1963 is an asset misappropriation fraud. (T/F)2TFQ The three elements of the fraud triangle include incentive, opportunity, and rationalization. (T/F)4TFQ 5TFQ 6TFQ 7TFQ 8TFQ 9TFQ 10TFQ 11TFQ 12TFQ 13MCQ 14MCQ 15MCQ 16MCQ 17MCQ 18MCQ 19MCQ 20MCQ 21MCQ 22MCQ 23MCQ 24MCQ 25RSCQ 26RSCQ 27RSCQ Refer to Exhibit 2.1 a. What is a Ponzi scheme? b. Describe the key elements of the Bernie Madoff fraud. c. Is this fraud primarily a case of asset misappropriation or fraudulent financial reporting?29RSCQ 30RSCQ 31RSCQ 32RSCQ 33RSCQ 34RSCQ 35RSCQ 36RSCQ 37RSCQ 38RSCQ Many consider the Enron fraud to be one of the most significant frauds of the early 2000s. a. Describe the various failures and environmental characteristics during this rime that enabled the Enron fraud to happen. b. What elements of the fraud triangle seem most relevant to the Enron fraud?40RSCQ 41RSCQ Refer to Exhibit 2.5 and answer the following questions. a. (Sections 101, 104, and 105) How does the establishment and operation of the PCAOB help to ensure quality external audits? How will audit firm inspections and investigations by the PCAOB help ensure high audit quality? b. (Sections 201-203) How do Sections 201-203 address audit ()r independence concerns? c. (Section 206) What is a cooling-off period, and how does it address auditor independence concerns? d. (Section 301) How do the audit committee requirements help ensure effective corporate governance? e. (Sections 302 and 906) How do the officer certification requirements help to address the risk of fraud in publicly traded organizations? What is the likelihood that a CFO who is committing fraudulent financial reporting would sign the certification falsely, and what are your reactions to that possibility? f. (Section 401) How does this section relate to the Enron fraud? g. (Section 404) How do the management assessment and audit or attestation of internal controls contained in this section help to address the risk of fraud in publicly traded organizations? h. (Section 407) Why is it important that at least one member of the audit committee be a financial expert? What are the financial reporting implications if the audit committee does not have any individuals serving on it who possess financial expertise? i. (Section 802) How does this section relate to the Enron fraud?43RSCQ 44RSCQ 45RSCQ 46RSCQ 47RSCQ 48RSCQ 49RSCQ 50FF 51FF 52FF 1TFQ 2TFQ 3TFQ 4TFQ 5TFQ The control environment is seen as the foundation for all other components of internal control. (T/F)7TFQ 8TFQ 9TFQ 10TFQ 11TFQ 12TFQ 13TFQ 14TFQ 15TFQ 16TFQ 17TFQ 18TFQ 19TFQ 20TFQ 21MCQ 22MCQ What are the components of internal control per COSO’s Internal Control—Integrated Framework? a. Organizational structure, management philosophy, planning, risk assessment, and control activities. b. Control environment, risk assessment, control activities, information and communication, and monitoring. c. Risk assessment, control structure, backup facilities, responsibility accounting, and natural laws. d. Legal environment of the firm, management philosophy, organizational structure, control activities, and control assessment.24MCQ 25MCQ Which one of the following components of internal control over financial reporting sets the tone for the organization? a. Risk assessment. b. Control environment. c. Information and communication. d. Monitoring.27MCQ 28MCQ 29MCQ 30MCQ 31MCQ 32MCQ 33MCQ 34MCQ 35MCQ 36MCQ 37MCQ 38MCQ 39MCQ 40MCQ 41RSCQ 42RSCQ 43RSCQ 44RSCQ Distinguish between entity-wide and transaction controls. Which components of internal control are typically entity-wide controls? Which components of internal control are typically transaction controls?Refer to Exhibit 3.2. List the principles representing the fundamental concepts of the control environment component.47RSCQ 48RSCQ 49RSCQ 50RSCQ Refer to Exhibit 3.3. For each risk assessment principle, provide an example of how an organization might apply that principle.52RSCQ 53RSCQ 54RSCQ 55RSCQ 56RSCQ 57RSCQ 58RSCQ Authorization of transactions is a key control in most organizations. Authorizations should not be made by individuals who have incompatible functions. For each transaction (listed as A through I), indicate the individual or function (e.g., the head of a particular department) that should have the ability to authorize that transaction. Briefly provide a rationale for your answer. a. Writing off old accounts receivable. B. Committing the organization to acquire another company that is half the size of the existing company. C. Paying an employee for overtime. D. Shipping goods on account to a new customer. E. Purchasing goods from a new vendor. F. Temporarily investing funds in common stock investments instead of money market funds. G. Purchasing a new line of manufacturing equipment to remodel a production line at one of the company’s major divisions (the purchase represents a major new investment for the organization). H. Replacing an older machine at one of the company’s major divisions. I. Rewriting the company’s major computer program for processing purchase orders and accounts payable (the cost of rewriting the program will represent one quarter of the organization’s computer development budget for the year).60RSCQ 61RSCQ 62RSCQ 63RSCQ 64RSCQ 65RSCQ 66RSCQ 67RSCQ 68RSCQ Refer to Exhibit 3.9. What are the important features of management’s report on internal control over financial reporting?Refer to Exhibit 3.10 and Exhibit 3.11. Describe management’s process for evaluating internal control over financial reporting. For the control environment principles, identify evidence that management might obtain to assess the operating effectiveness of the control environment.71RSCQ 72RSCQ 73RSCQ 74RSCQ Assume that management is gathering evidence as part of its process for assessing the effectiveness of internal control over financial reporting. The company is a manufacturer of high-dollar specialized Control Tested machines used in the medical profession. The following table identifies important controls that management is testing regarding accounts related to revenue recognition, accounts receivable, and other sales related activities. The first column describes the control, and the second column describes the test results. Based on the test results, determine the conclusion that management should likely make about the deficiency. (Is it a control deficiency, a significant deficiency, or a material weakness?)76RSCQ 77RSCQ 78RSCQ 79FF Diamond Foods, Inc. (LO 8, 9) In February 2012, the Wall Street Journal reported that Diamond Foods, Inc. fired its CEO and CFO, and would restate financial results for two years. The restatement was required after the company found that it had wrongly accounted for crop payments to walnut growers. The investigation focused primarily on whether payments to growers in September 2011 of approximately $60 million and payments to growers in August 2010 of approximately $20 million were accounted for in the correct periods. Shareholders suing the company allege the payments may have been used to shift costs from a prior fiscal year into a subsequent fiscal year. In a February 2012 filing with the SEC, the audit committee stated that Diamond had one or more material weak nesses in its internal control over financial reporting. In January 2014, the SEC charged Diamond Foods and two former executives for their roles in the accounting scheme to falsify walnut costs in order to boost earnings and meet estimates by stock analysts. Diamond Foods agreed to pay $5 million to settle the SEC’S charges. a. Does the restatement suggest that the company’s internal controls contained a material weakness? Explain your rationale. b. In September 2011, the company filed its annual report with the SEC for its fiscal year ended July 31, 2011. As part of that filing, the company maintained that it had effective internal controls over financial reporting as of its year-end date. Do you believe that management’s report on internal control over financial reporting was accurate? c. In February 2012, the audit committee indicated that the company had ineffective internal controls. What types of material weaknesses do you think might exist at Diamond?1TFQ 2TFQ 3TFQ 4TFQ 5TFQ 6TFQ 7TFQ 8TFQ Utilitarian theory holds that what is ethical is the action that achieves the greatest good for the least number of people.10TFQ 11TFQ 12TFQ 13MCQ 14MCQ 15MCQ 16MCQ 17MCQ 18MCQ 19MCQ 20MCQ 21MCQ 22MCQ 23MCQ 24MCQ 25RSCQ 26RSCQ 27RSCQ 28RSCQ 29RSCQ 30RSCQ Refer to the Focus on Fraud feature “Moss Adams and the Meridian Mortgage Funds Fraud.” a. Why was Moss Adams sued by the trustee for the bankrupt Meridian Mortgage? b. What would the trustee have to prove in order for the courts to hold Moss Adams liable for damages?32RSCQ 33RSCQ 34RSCQ 35RSCQ 36RSCQ 37RSCQ 38RSCQ 39RSCQ 40RSCQ 41RSCQ 42RSCQ 43RSCQ 44RSCQ 45RSCQ 46RSCQ 47RSCQ 48RSCQ 49RSCQ 50RSCQ 51RSCQ Refer to Exhibit 4.4. Briefly explain the seven steps in the framework for ethical decision making. Provide an example of a difficult ethical decision that you have recently made, and use the framework to help you make a decision using the seven steps. (An example might be a decision to challenge a friend who has done something wrong or a decision to report on a person that you know was cheating on an exam.)53RSCQ 54RSCQ 55RSCQ 56RSCQ 57RSCQ 58RSCQ 59RSCQ 60RSCQ 61RSCQ 62RSCQ 63RSCQ 64RSCQ KPMG (LO 1, 2, 3) KPMG LLP served as the external auditor for some of the largest sub-prime mortgage lenders in the U.S. leading up to and during the housing market crisis of the mid to late-2000s. The audits of two of their largest lending clients, New Century Financial Corporation and Countrywide, ultimately led the firm to settle litigation charges in 2010 for $44.7 and $24 million, respectively. The business model of these two subprime mortgage lenders consisted of providing loans to borrowers with weak credit histories. The business model had begun to fail during 2007, when the economy weakened, borrowers began defaulting, and home prices declined drastically. New Century filed for bankruptcy and Countrywide was purchased by Bank of America, which subsequently suffered massive losses related to business failures at Countrywide. Just before the housing crash of 2007 put the companies in severe financial crises, KPMG had given both companies unqualified audit opinions. In both cases, KPMG was subsequently accused of violating professional standards, lacking independence, and being negligent. K PMG defended itself by arguing that its audits were not the cause of the financial woes at New century and Countrywide. Rather, the firm contended that the failed business model of the two companies led to investor losses. a. How does the economic environment affect the litigation risk faced by audit firms? b. Should auditors be held liable if their client’s business fails or if the financial statements contain a fraud that the auditors did not detect? c. What defenses do auditors use in response to litigation? d. What actions can auditors take to minimize litigation exposure?66FF 1TFQ 2TFQ 3TFQ 4TFQ 5TFQ 6TFQ 7TFQ 8TFQ 9TFQ 10TFQ 11TFQ 12TFQ 13TFQ 14TFQ 15TFQ 16TFQ 17TFQ 18TFQ 19TFQ 20TFQ 21TFQ 22TFQ 23TFQ 24TFQ 25MCQ 26MCQ 27MCQ 28MCQ 29MCQ 30MCQ 31MCQ Which of the following accounts would not be included in the Acquisition and Payment for Long-Lived Assets Cycle? a. Revenue b. Depreciation expense c. Gain on disposal d. Equipment 33MCQ Which management assertion addresses whether the components of the financial statements arc properly classified, described, and disclosed? a. Completeness. b. Existence. c. Rights and obligations. d. Presentation and disclosure. c. None of the above address whether the components of the financial statements arc properly classified, described, and disclosed.35MCQ 36MCQ 37MCQ 38MCQ 39MCQ 40MCQ 41MCQ 42MCQ 43MCQ 44MCQ 45MCQ 46MCQ

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