Chapter B, Problem 48EP

a.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

Auditor’s Independence:

Auditor’s independence ensures that auditor conducts audit in a fair manner and as per the established standards and rules without any bias or managerial influence that may affect the work performed.

As per the given case failure to detect inventory overstatement of $800,000 caused by employee and falsification of the records has damaged the independence rule. Independence rule is considered to be damaged when a strong possibility is assessed by the accounting firm that there is a explicit intention of the client to begin a lawsuit in order to claim damage.

b.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

Independence rule is considered to be damaged when there is lawsuit claiming damage against the negligent audit work conducted by an auditor. In the given case, a damage claim of $1 million is claimed by filing lawsuit alleging negligent audit work by Company C. Therefore the independence rule is considered to be damaged.

c.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

Independence rule is considered to be damaged when a public accounting firm files litigation against the management the entity under audit. In the given case, a damage claim of $500,000 is claimed by accounting firm from Company C alleging management fraud and deceit. Therefore the independence rule is considered to be damaged.

d.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

Independence of an auditor is not affected by the claim for negligence in the performance in the audit work by an auditor. In the given case, Company A is suing public accounting firm on the ground that if proper audit was conducted the theft would have been uncovered sooner and amount of loss would have been less. Therefore, it can be concluded that independence of the public accounting firm may get damaged if management of Company C tests the situation in the interest of the insurance company.

e.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

In the given case a claim is made by the management of Company S on the public accountant to return the fees of $10,000 paid by the company for installation of a cost accounting system. The service rendered by the public accountant is not of the auditing nature. Since, the service provided by the public accountant is other than that of auditing it will not damage the independence of the public accounting firm with its client.

f.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

In the given case a claim was made through a lawsuit by the dissident shareholders on the public accounting firm and its client Company A claiming $30 million. The independence of the auditor is not affected by a lawsuit filed by the dissident shareholders. Therefore, the lawsuit so filed will not damage the independence of the public accounting firm and Company A.

g.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

In the given case, CPA L a shareholder of Firm B owns 25% of the common stock of Company D. Company D has purchased an interest of Company T. The investment in the consolidated net asset of Company D is 11%. Company T is been audited by Firm B from past 12 Years. Therefore, from the interpretation of the given case we can conclude that independence of Firm B with Company D is being damaged due to the shareholding of CPA L in company D. However, the independence of Firm B with Company T will not be affected since CPA is not holding any shares directly in the Company T.

h.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

In the given case, CPA M and B of LLP Q holds 12% investment in Company H. Company H is not an audit client of LLP Q. LLP Q has an audit client Company Ho which owns as stake of 46% of Company H. Thus, we can say that LLP Q has an influential right in Company H and in Company Ho by virtues of its shareholding of 46% in Company H. Therefore, it can be concluded that the independence rule between LLP Q and Company H and Company Ho is damaged.

i.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

• The given case states that two directors of audit client of CPAs D and M became partners with CPA D and M. The directors so indulged did not conducted audit work of Bank N. Therefore, we can conclude that independence of CPA D and M will not be considered damaged as the directors became their partners after resignation from Bank N and did not participated in the audit work.
• Further, the former controller of Bank N was frequently approached by the bank to provide assistance regarding loan and bank’s minimum checking account policy. It can be interpreted that if the controller is having appropriate authority to take management decisions of Bank N then the independence of the firm will not be considered damaged. However, if no such authority exist then objectivity might get damaged and ultimately affect the independence of the accounting firm.

j.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

In the given case, Company C has offered CPA an unsecured interest-bearing note or 2 shares from its common stock in order to settle its unpaid fees. Acceptance of shares from common stock as auditing fee will not damage the independence of the CPA till the mode of payment of fees is properly mentioned in such situation. If, Company C fails to mention such mode of payment then independence of CPA will be considered as damaged.

k.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

In the given case, Mrs. D has received material at a discount of 70% for remodeling of her house from the controller of Company R. As per facts of the case Mrs. D is neither a CPA nor a member of ACIPA. Hence, Mrs. D will not come under the purview of code of ethics framed by ACIPA. An employee of accounting firm is not permitted to break the rules framed by ACIPA. Therefore, it can be concluded that Mrs. D has not violated code of ethics. However, independence of the firm will be considered to be damaged as employee of the accounting firm has broken the rules framed by ACIPA.

l.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

Given case provide a fact stating that audit fee for the previous and current year has not been paid for the audit work done by the CPA. Any outstanding fee payable to CPA is considered as debt. Therefore, independence of CPA is considered to be damaged as the outstanding fees of current and previous year has not been paid.

m.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

Facts of the given case provide information about the professional negligence of CPA A who has omitted the sale of inherited property in order to reduce the profit to the extent of $200,000. The act done by CPA A reflects the violation of rules framed by AICPA for integrity and objectivity of a CPA or its member. The over-payment of tax for previous year could have been rectified by filing an amended return. Adjustment of the over-paid tax for last year through omission of sale of the inherited property is not in order.

n.

To determine

Discuss whether action or situation of the given case shows a violation of the AICPA Code of Professional Conduct. Also explain the reason and cite relevant rule or interpretation.

Explanation of Solution

In the given case, CPA S and L have misappropriated the disclosure of $750,000 through a falsified entry posted in prepaid expenses. Also, external auditors are misled by CPAs as false information is provided with respect to the repayment terms and related-party loan. Thus, violation of Rule 102 is evident from the acts performed by both the CPAs. Also, inappropriate classification by CPA L has violated the discreditable rule provided by AICPA.