Auditing

1. Why would the owners of Lakeside as well as the company’s banks require that an independent CPA firm perform the annual audit? The reason that there needs to be an independent auditor is so that they can remain unbiased. It could potentially make them less independent if they are auditing both Lakeside and the bank in which Lakeside is taking loans from. The auditing firm needs to stay independent in mind and appearance and this may be an issue when auditing both. 2. This case implies that no auditor with the firm of Abernethy and Chapman has an in-depth understanding of the consumer electronics industry. Is a CPA firm allowed to accept an engagement without having established the necessary expertise to oversee the audit? The first general standard of Generally Accepted Auditing Standards is that the auditor must have formal education in auditing and accounting, adequate practical experience for the work being performed, and continuing professional education (Kursh, Lant, et Al, 2014, pgs. 32-33). Therefore they should not accept the engagement. Would the knowledge required to audit a consumer electronics company differ significantly from that needed in the examination of a car dealership? The knowledge required to audit a consumer electronics company is significantly different than that needed to audit a car dealership. Does the auditor have an obligation to discuss his lack of expertise, or his plans to obtain the expertise with the client? The auditor does have an ethical obligation to discuss his lack of expertise, as well as discussing if he plans on hiring someone with expertise specifically for this client. 4

Rogers wants Abernethy and Chapman to assist his company in developing new accounting systems. Does a CPA firm face an independence problem in auditing the output of systems that the same firm designed and installed? Yes, if a CPA firm were to develop new accounting systems specifically for the company then they would lack the independence needed to test them. Therefore Rogers should have hired a consulting or software development company to help develop a new accounting system as it could not have been completed by the auditing firm doing the current audit. Also, since this is a public company the SEC website states: “Financial information systems design and implementation. Designing and implementing a hardware or software system used to generate information that is significant to the audit client's financial statements may create a mutual interest between the client and the accountant in the success of that system, supplant a fundamental business function, or result in the accountant auditing his or her own work” (SEC, 2000, para 18). Does your answer depend on if the client is publicly traded or not, how so? Yes, publicly traded companies are monitored by the AICPA Code of Professional Conduct requirements which do allow this.

Kursch, Steven R., Lant, Theresa K., Majeske, Karl D, Oliver, James M., Plant, R (2014). Auditing and Assurance Services (14th ed.). Boston, MA: Pearson Learning Solutions. SEC. (2000, June 27). Fact Sheet: The Commission’s Proposal To Modernize the Rules Governing the Independence of the Accounting Profession. Retrieved August 17, 2014, from, http://www.sec.gov/news/extra/audfact.htm.

Case 1 - Exercise 1 Abernethy and Chapman Fraud Risk Factors

Client: Lakeside Company Prepared by: Brandy Craig Date: March 2012

List the fraud risk factors that the CPA firm might encounter if they accept this audit engagement. Be sure to include a discussion of all items that will probably require special attention during the audit. For each of these fraud risk factors, indicate how the auditor should follow up on each potential problem if the engagement is accepted. Use the following format:

Fraud Risk Factors

Auditor Follow Up

Management may have the incentive to overstate the income since their raises are directly tied to income

Testing should be completed to verify all revenue from stores.

Abernathy and Chapman use the same back that Rogers does.

All issues related to independence should be considered.

Lack of Expertise

A skilled person should be hired to handle this audit.

Similar electronic companies have bankrupt recently Factors about the stability of the industry should be reviewed. Sales and Returns

The timing between sales and returns would need to be looked at to verify that false sales aren’t being recorded due to timing differences.

New Business strategies

Look into the business strategy and the mission statement of company as well as speaking with

upper management. Misappropriation of assets

Inventory would need to be audited

Unhappy with previous firm

Rogers does not like the previous firm because he did not like the qualified status that they gave his company.

Unwillingness to fix the previous audit

They would need to figure out why there was an unwillingness to fix the previous audit by speaking to upper management.

Case 1 - Exercise 2

King and Company PRO FORMA AUDITOR'S REPORT

To: Benjamin M. Rogers Lakeside Company We have audited the accompanying balance sheet of Lakeside Company as of December 31, 2011, and the related statements of income, retained earnings, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. The value of Lakeside’s $186,000 investment in its latest store is impaired based on guidelines established by the FASB. In our opinion Lakeside should write down the reported value of the property. In our opinion, because of the effects of the matters discussed in the preceding paragraph, the financial statements referred to above do not present fairly, in conformity with accounting principles generally accepted in the United States of America, the financial position of the Lakeside Company at December 31, 2011, or the results of its operations and its cash flows for the year then ended. As discussed previously the value of Lakeside’s sixth store is currently held at historical value and is impaired, needing to be written down to fair market value. The shopping center that is adjacent to the store has proven to be very unsuccessful and has only leased 40% of available spaces. Lakeside has not been able to generate the customer traffic necessary to come close to a break-even point. Lakeside will have considerable trouble in disposing of the store if necessary.

King and Company,Certified Public Accountants Date: December 31, 2011