Question 2.

A CPA-firm does not guarantee the financial soundness of a client when it renders an opinion on
financial statements, nor does the CPA firm guarantee the absolute accuracy of the statements.

Yet the CPA firm’s opinion is respected and accepted. What is expected of the CPA firm in order to
merit such confidence?

Question 2.2

What is a ‘material’ amount from the perspective of auditors?

Give an example of how that amount may differ based on the nature of the item.

Question 2.3

An attitude of independence is a most essential element of an audit by a firm of CPA.

Describe several situations in which the CPA firm might find it somewhat difficult to maintain this
independent point of view.

Question 2.4

Jane Lee, a director of a nonpublic corporation with a number of stockholders and lines of credit with
several banks, suggested that the corporation appoint as controller John Madison, a certified public
accountant on the staff of the auditing firm that had made annual audits of the corporation for many
years. Lee expressed the opinion that this move would effect a considerable savings in professional
fees because annual audits would no longer be needed.

She proposed to give the controller, if appointed, an internal auditing staff to carry on such
continuing investigations of accounting data as appeared necessary.

Evaluate this proposal.

Question 2.5

What is the meaning of ‘quality control’ and ‘peer review’ as these terms relate to the operation of a
CPA-firm?

Is peer review mandatory?

Question 2.6

Match each of the following statements with the appropriate type of auditors’ report.

A. Adverse D. Disclaimer Q. Qualified S. Standard unmodified (standard unmodified means

that the auditors think the report need no changes)

Statement Type of Audit Report

The auditors are unable to determine the overall fairness of

the financial statements.

This is the report most clients prefer.

A limitation on the scope of the audit is significant, but not

so as to overshadow an overall opinion

The financial statements are not fairly presented

A material departure from GAAP exists, but not so material

as to overshadow an overall opinion.

Question 2.7

Hide-It
Hide-It (Hl), a family-owned business based in Tombstone, Arizona, builds custom homes with special
features, such as hidden rooms and bidden wall safes. Hide-It has been an audit client for three years.

You are about to sign off on a “clean” opinion on HI’s current annual financial statements when Art
Hyde, the VP-Finance, calls to tell you that the Arizona Department of Revenue has seized control of a
Hide-It bank account that includes about $450,000 of company funds; the account is not currently
recorded in the accounting system and you had been unaware of it. In response to your questions
about the origin of the funds, Art assures you that the funds, though not recorded as revenue, had
been obtained legitimately. He explains that all of the money came from separately billed but
unrecorded change orders to items in contracts completed before you became HI’s auditor, and before
he or any members of current management became involved with the company. You subsequently
determine that there is insufficient evidence to allow you to reconstruct the nature of these cash
transactions, although the following analysis is available from the Arizona Department of Revenue:

Deposits 1/17/2013-12/3/2015 $455,000

Interest earned 1/2/2013-12/31/2019 95,000
Withdrawals 2/12/2014^1/7/2018 (100,000)
Balance 12/31/2019 $450,000
Art also informs you that Hl has agreed to pay a combined tax and penalty of 12 percent on the total
funds deposited within 120 days as required by a recently enacted rule that pro vides amnesty for tax
evaders. Furthermore, he States that negotiations with the Internal Revenue Service are in process.

Required:
a) The professional standards define errors as unintentional misstatements or omissions of amounts
or disclosures in the financial statements. Is the situation described an error?
b) The professional standards state that fraud relates to intentional misstatements or omissions of
amounts or disclosures in the financial statements. Misstatements due to fraud may occur due to
either (a) fraudulent financial reporting or (b) misappropriation of assets. Does the situation appear
to be fraud? If so, is it fraudulent financial reporting, misappropriation of assets, or both?
c) The professional standards outline certain auditor responsibilities relating to identifying client
noncompliance with laws and distinguish between laws with a “direct effect” on the financial
statements and other laws. Does the situation herein relate to noncompliance with laws as
discussed within the auditing standards? If so, is the noncompliance related to a law with a direct
effect on the financial statements or another law.
d) Should the CPA firm resign in this situation? If the decision is not clear-cut, what additional
information would you desire before deciding?

Question 2.8

Enormo
Enormo Corporation is a large multinational audit client of your CPA firm. One of Enormo’s
subsidiaries, Ultro, Ltd., is a successful electronics assembly company that operates in a small
Caribbean country. The country in which Ultro operates bas very strict laws governing the transfer of
funds to other countries. Violations of these laws may result in fines or the expropriation of the assets
of the company.

During the current year, you discover that $50,000 worth of foreign currency was smuggled out of the
Caribbean country by one of Ultro’s employees and deposited in one of Enormo’s bank accounts.
Ultro’s management generated the funds by selling company automobiles, which were fully
depreciated on Ultro’s books, to company employees.

You are concerned about this illegal act committed by Ultro’s management and decide to discuss the
matter with Enormo’s management and the company’s legal counsel. However, Enormo’s
management and board of directors seem to be unconcerned with the matter and express the opinion
that you are making far too much of a situation involving an immaterial dollar amount. They also
believe that it is unnecessary to take any steps to prevent Ultro’s management from engaging in illegal
activities in the future. Enormo’s legal counsel indicates that the probability is remote that such an
illegal act would ever be discovered, and that if discovery were to occur, it would probably result in a
fine that would not be material to the client’s Consolidated financial statements.

Your CPA firm is ready to issue the integrated audit report on Enormo’s financial statements and
internal control for the current year, and you are trying to decide on the appropriate course of action
regarding the illegal act.

a) Discuss the implications of this illegal act by Ultro’s management.

b) Describe the courses of action that are available to your CPA firm regarding this matter.
c) State your opinion as to the course of action that is appropriate. Explain.
Question 2.9

White Company

Joe Rezzo, a college student majoring in accounting, helped finance his education with a part-time
job maintaining all accounting records for a small business, White Company, located near the
campus.

Upon graduation, Rezzo passed the CPA examination and joined the audit staff of a national CPA firm.
However, he continued to perform all accounting work for White Company during his ‘leisure time’.

Two years later, Rezzo received his CPA certificate and decided to give up his part-time work with
White Company. He notified White that he would no longer be available after preparing the year-end
financial statements.

On January 7, Rezzo delivered the annual financial statements as his final act for White Company.
The owner then made the following request: ‘Joe, I am applying for a substantial bank loan, and the
bank loan officer insists upon getting audited financial statements to support my loan application.
You are now a CPA, and you know everything that’s included in these financial statements, and you
know they give a fair picture. I would appreciate it if you would write out the standard audit report
and attach it to the financial statements. Then I’ll be able to get some fast action on my loan
application’.

a) Would Rezzo be justified in complying with White’s request for an auditor’s opinion? Explain.
b) If you think Rezzo should issue the audit report, do you think he should first perform an audit of
the company despite his detailed knowledge of the company’s affairs? Explain.
c) If White had requested an audit by the national CPA firm for which Rezzo worked, would it have
been reasonable for that firm to accept and to assign Rezzo to perform the audit? Explain.