Ateneo de Zamboanga University

School of Management and Accountancy

Case 6: Murchison Technologies Inc.

AN AUDIT CASE ANALYSIS ACTIVITY

A Requirement in
EXTAUD 1 - Auditing and Assurance Principles

Submitted to:
Ms. Sheila Mae J. Gabo

Submitted by:
Kyla Marie J. Blando

March 31, 2023

SUMMARY
Software created by Murchison Technologies, Inc. is targeted at helping those working in
the medical industry. Jim Archer, a software developer, and Janice Johnson, a sales
professional, launched the business five years ago. Both of the company's founders are
currently Board of Directors members and have additional operational positions. The company's
chief executive officer is Janice, while Jim is its president. They regularly develop, update, and
build software alongside their staff—the majority of whom are software programmers—for the
benefit of the medical industry.
After three years of arduous work, the company introduced its first product—a patient-
billing software system sold as a MEDTECH Software—to the market in early 2012. This
software is intended to make it easier for patients to keep track of the costs associated with the
services rendered by doctors, dentists, and other medical personnel. Doctors and dentists have
so far given the product favorable reviews. They gave the software good marks for its
adaptability in tracking patient fees, as well as for its customizable features, little upgrade
requirements, and affordable quality. Since the product's original release in 2012, sales have
been robust due to the many positive reviews.
Custer & Custer, LLP is used by Murchison to carry out certain accounting tasks. The
corporation is now working to finish the audit of the organization's financial accounts as of
December 31, 2014. The vast majority of the thorough audit testing has already been finished.
The tests assisted the auditors in noting an alleged copyright infringement lawsuit against
Murchison that, according to the client, has a minimal likelihood of succeeding. In addition, the
client has asked the firm to contact legal firms in order to seek the customary attorney letter
response regarding any pending significant claims against the client, in order to complete the
audit report.

REQUIRED
1. Review the requirements in the Accounting Standards Codification (ASB) that
address the accounting for contingencies. Describe the three ranges of loss
contingencies outlined in the accounting standards and briefly summarize the
accounting and disclosure requirements for each of the three ranges.
According to Deloitte, n.d., loss contingency refers to an existing situation,
circumstance, or condition that is uncertain as to potential loss to an entity and
would only be resolved when future events do or do not happen. The three ranges
of loss contingency defined by the accounting standards are as follows:
1. Probable- The future event/s are likely to occur. Thus, loss would also be likely to
occur.
● Accounting Requirements- Will always be disclosed in the Financial
statements. The estimated loss shall be accrued by a charge to income. It should be disclosed
at the same period it was recognized.
● Disclosure Requirements
○ If Probable and Reasonably Estimable a. The nature of the
contingency.
b. The total amount of the loss that has been recognized (if such
disclosure is required to ensure that the financial statements are not misleading).
c. A statement indicating that it is at least reasonably possible that
the estimated amount of the loss will change in the near term.
d. The exposure to loss in excess of the amount accrued under ASC
450-20 if there is at least a reasonable possibility that such excess loss may have been
incurred.
○ If Probable and Not Reasonably Estimable
a. The nature of the contingency.
b. A statement that the amount of the loss cannot be reasonably
estimated

2. Reasonably Possible- The probability of the future event/s to occur is more than
remote but less than likely. The loss would also be likewise.
● Accounting Requirements- Disclosed only in the footnotes of the Financial
Statements
● Disclosure Requirements- The disclosure shall include the following:
a. The nature of the contingency
b. An estimate of the possible loss or range of loss or a statement that such
an estimate cannot be made.
c. A statement indicating that it is at least reasonably possible that the
estimated amount of the loss will change in the near term.

3. Remote- The probability of the future event/s to occur is slight. Therefore, there
would also be a slight chance for the loss to occur.
● Accounting Requirements- Ignore.
● Disclosure Requirements- There are no specific requirements related to
remote contingencies. However, disclosure may be provided if its omission could cause the
financial statements to be misleading.

2. Based on your review of the attorney’s confirmation, which of the three ranges of
probability of loss do you think the Physicians Software Inc., claim falls? How does that
assessment differ from management’s assessment of the loss probability?
The attorney’s confirmation stated a different probability for loss than the management’s
claim regarding the copyright infringement suit against Murchison. According to the
attorney’s confirmation, they claim that the probability of loss is “more than remote but less
than likely.” Thus, this assessment falls under the Reasonably Possible range of loss
contingency. On the other hand, Murchison’s management claimed that there is an
extremely low probability of an unfavorable outcome. Thus, the management’s claim falls
under the Remote range of loss contingency. Furthermore, the attorney’s confirmation has
concluded that the copyright infringement suit should be disclosed or be considered
 for disclosure in the December 31, 2014 financial statements. While management
claimed that this issue is immaterial for the financial statements of the said year.

3. Assume that Dunn & King's letter did not include their assessment that the
outcome "...in this case, is more than remote but less than likely" but instead included
one of the following statements. What action would you take in response to each
scenario (consider each statement independently)?
a. "We believe the plaintiff's case against the company is without merit."
We will disclose the pending case against us as auditors in the report. Murchison
Technologies, Inc., along with the legal opinion provided by Dunn & King in the
letter, since this will lessen the company's risk. In this regard, we will specifically
address the lack of risk to the corporation posed by the aforementioned case,
using the expert opinion of Dunn & King as evidence.

b. "We believe that a negative outcome for Murchison is most likely, but we
are unable to assess the amount of damages that might be imposed."
We will evaluate the impact of this case in relation to the corporation's overall
financial liabilities because this means that the company has a chance of losing
the case. Following that, we must assess if the company can withstand the
impact of this financial burden, as well as predict the danger that this poses to
the company's future.
c. "This action involves unusual circumstances where there is no prior legal
precedent. We think the Physicians Software will have difficulty establishing liability for
Murchison; however, if Physicians Software is successful, the settlement would be
substantial."
In this case, if the plaintiff is successful in proving that Murchison violated
copyrights, the firm will face a material financial consequence. Since there is a
chance of losing, the same course of action as before should be followed. First,
we'll need to figure out how this would affect the company's overall financial
liability. Second, we must determine if the corporation is capable of bearing the
consequences of this liability. Finally, projections on the risk involved in the
company's future should be included.

4. Discuss why the attorney’s letter is being received so close to the completion of
the audit. Was the request for the attorney’s response an oversight that should have
been taken care of closer to December 31,2014, or was Custer &Custer appropriate in not
requesting the response until the end of the audit?
In this case the request for attorney’s response was not an oversight on the part of the
auditors because the outstanding claim is a contingent event in which a loss on
contingency usually depends on the outcome of the future event that is why it is
appropriate that the Custer & Custer did not request for an Attorney’s response until the
audit is almost complete. It is therefore guaranteed that an attorney’s assessment can
be more liable since the auditor can evaluate relative and appropriate evidence gathered
and determine whether the future developments with regards to the loss can affect the
 range of contingency. The request for attorney’s response was not an oversight but it
was a proper course of action so that the information could be used most practically.

5. Assuming that management and the attorney’s assessments differ, how would
you resolve such differences when assessing the potential for an unfavorable outcome
associated with the claim? What are the pros and cons of relying on the attorney’s
assessment versus management’s assessment?
If the assessment of the management and attorney are different from each other, it is
most likely that the parties have failed to share relevant information which probably
explains the differences of each other’s assessment. However, it is the management’s
responsibility to provide and update financial statements that would reflect business
operations and projection regarding possible losses.
It is indeed that relying on the attorney’s assessment is a good move because it is more
reliable and conservative because the response of the attorney is an external document
which means that it is independent and objective in nature. The auditor can rely more on
the independent and external source of information against the internal assessment
made by the management because the risk and possibility of being bias is high most
especially that every company aims to provide a positive ad better financial statements
which it can interfere its authenticity by not including some necessary disclosures as well
as making the pretax earnings appear better because they don’t want to include
potential losses.
However there is also a disadvantage in relying with an attorney for the reason that an
assessment might be too negative or tend to overestimate an unfavorable outcome
which could harm the financial statements to reduce the risk of taking accountability for
presenting inaccurate assessment.

6. In preparation for tomorrow’s meeting with the partner and likely subsequent
meeting with Murchison management, develop recommended responses to the following
possible scenarios. In developing your responses, assume that each scenario is
independent of the others:ney’s assessment versus management’s assessment?
a. If generally accepted accounting principles require disclosure of this
contingency, how would you respond to management’s decision against disclosure
because they view the claim as immaterial to the December 31, 2014 financial
statements? Do you believe the potential loss is material? Why or why not?
Contingent liability is a disclosure in the notes to financial statements only. Unlike
provisions, contingent liabilities are not recognized in the statement of financial
position or P/L.
Since the assessment of the law firm regarding the contingency is said to be
more than remote but less than likely, this also indicates "reasonably possible but
not probable". As a result, contingencies must be disclosed. Having stated that,
as auditors, we strongly encourage disclosure and will work with management to
convince them to report such contingencies as required by GAAP. Since the
 materiality concept is based on professional judgment, there are no specific
criteria for establishing whether liability is material or not. However, a materiality
threshold is still based on professional judgment and other probable factors. As
an auditor, we believe that the potential loss from the contingent liability is
material to the company. It is significant because it accounts for around 11% of
the company's pretax income and because failure to disclose it could affect the
entity's reputation in the industry and raise questions among investors, creditors,
and other stakeholders. Non-disclosure of the contingency, although GAAP
requires it, may place the company in a compromising position for failing to meet
one of the criteria.

b. Assume that even though you convince management that the claim is
material, they refuse to provide any disclosure that might be required. Prepare a draft of
the auditor’s report that would be issued in that scenario. In this scenario, management
has the option of omitting materials footnote information, which is a violation of accounting
principles. In this case, the management and the auditor agree on the likely possibility of the
material. This is due to the occurrence of an outcome that falls within the scope of the
reasonably possible, requiring no accounting entry. The balance sheet and statement income
information are stated on a fair note. This page does not include the required footnote.

c. Assume that you determine, through subsequent discussions with the

attorney, that a more likely estimate of the range of loss falls between $50,000 and
$75,000. What type of financial statement disclosure do you believe is required in that
case? Prepare a draft of the auditor’s report that you would issue in that scenario.
In this scenario, disclosure is not required because the range of loss falls
between $50,000 and $75,000. This is below the estimated materiality, so it is
immaterial to the financial statements of Murchison Technologies. It would not
produce any significant effect to the entity whether the contingency occurs or not.
Therefore, as auditors, we will issue an unqualified opinion audit report.

d. Assume that you determine, through subsequent discussions with the

attorney, that a more likely estimate of the range of loss falls between $90,000 and
$115,000. What type of financial statement disclosure do you believe is required in that
case?
In this case, disclosure is also not required because the range of loss falls
between $90,000 and $115,000. This means that it is still not higher than the
estimated materiality, so it is also considered immaterial to the financial
statements of Murchison Technologies.
e. What if you learn that management has pertinent information available
about the case (and the case is deemed material) but refuses to share that
 information with you? Prepare a draft of the auditor’s report that you would
issue in that scenario.

f. Assume that you convinced management to disclose the contingency in

the footnotes to the December 31, 2014 financial statements and that your audit report on
those financial statements was a standard, unqualified audit report. What would your
responsibilities be if you learned two months after the issuance of the report that
Murchison settled the case for $340,000?
In this case, it is possible to conclude that the management conformed with the
requirements of the Generally Accepted Accounting Principles (GAAP) by
disclosing the contingency in the footnotes to the financial statements as of
December 31, 2014. The $340,000 settlement has no bearing on the auditor's
report or accountability. As a result, the auditor's unqualified opinion is right. The
settlement indicates a subsequent finding of fact that happened after the auditor's
report was issued. As a result, after the audit tests were finished, the previously
released financial statements were honestly presented. There would be no more
auditing action necessary.

g. Assume that the settlement of the litigation prohibits future sales of

MEDTECH software. What implication would that have on the auditor’s report on the
December 31, 2014 financial statements?
The revenue of Murchison solely comes from selling of MEDTECH software,
therefore if settlement of the litigation prohibits the future sales of MEDTECH
software,it would create substantial doubt about the company’s ability to continue
as a going concern. The company must proceed by disclosing this in the financial
statement of Murchison Technologies, in accordance with the standards. Once
the matter of disclosure has been amended, the auditor will then issue an
unqualified opinion. The auditor should also add another paragraph to discuss
the important matter as this can affect the decision of the users. On the other
hand, it will be reported as a qualified opinion stating the material misstatement
due to lack of disclosure, if the company refuses to amend their financial
statement to be able to disclose the litigation settlement.

h. Assume that Custer & Custer was delayed a month in completing the
collection of audit evidence. What actions would be appropriate relating to gathering
evidence about potential contingencies?
In gathering evidence about potential contingencies, the auditor’s should provide
a solid proof through alternative procedures such as reviewing minutes of
meetings, evaluating litigation that existed at the date of reporting financial
statements, through reviewing legal expense accounts and invoices form
external legal counsel, etc. However, if the auditor failed to provide the necessary
evidence to support his report or his claims, then it will be deemed as unqualified
opinion.
7. Review the ABA policy statement excerpts in Exhibit 1. What limitations exist as it
relates to the attorney’s response? To what extent should auditors rely solely on
attorney responses to identify outstanding claims against audit clients? Limitation
Relating to Attorney’s response.
● If an outstanding claim is not coming from the attention of an attorney and
auditors only rely on the attorney’s responses, there will be an omission of litigation and of
outstanding claims not coming to the attention of the attorney. For a reason that it is possible
that the client received an outstanding claim before the end of fiscal period and did not share or
forward to the attorney so as a result it was not included in the responses since the attorney has
no information thereof.
● A latest information or an updated information is not included in the attorney’s
responses given that a time gap exists between the issuance of the auditor's
report and the receipt of the attorney's responses.
Extent that can rely on Attorney’s response
There is a certain extent that an auditor can rely on the responses of the attorney in
identifying outstanding claims most especially that attorney is a credible person and is
presumably a master to all litigation. With that being stated, if the engagement of the
client together with its attorney is on a timely basis and the client conforms with its
obligation of forwarding the necessary information to the attorney, then it is in no doubt
that an auditor can conclude that the client has effective and efficient internal controls
about litigations which is an indication that it has a relatively low control risk.