Jawaban Case 5.3

Case 5.3: The North Face, Inc.

1. I believe auditors should not insist that their clients accepted all proposed audit adjustments when it is immaterial because as per AU section 312 (05), the auditor is not responsible to obtain reasonable assurance if the misstatement is not material to the financial statements. With that  being said, the auditor could propose the audit adjustments to their clients but cannot insist  because the inclusion or the exclusion of the misstatement would not have a material effect on the financial statements.

2. Auditor should take explicit measures to prevent preven t their clients from knowing the materiality threshold used in the audit. A perfect example was provided in “The North Face” case, Crawford

was aware of the materiality level for his audit engagement so he knows that his plan would not  be questioned by the Deloitte audit team because it was under the materiality level set for his audit engagement. If Crawford was unaware of the materiality threshold, he might not have plan the fraudulent scheme because he would not have been able to provide an appropriate answer for the gross profit of $800,000.

Auditor and clients do have to have open communication and it is hard for auditors to conceal this information because first, if the client feels that the auditor is not be ing open about the engagement, they might act in the same matter. This would result in a more difficult audit engagement. Second, based on information requested by auditors, the company would have a general idea on where the materiality threshold is because they would be requesting requ esting for, let say for example, invoices above a certain dollar amount, this would have revealed revea led the materiality threshold for the audit engagement.

3. The guidance for revenue recognition is governed by FASB Accounting Standards Codification topic 605, where 605, where it states that revenue should be recognized when realized or realizable. Realized means that the company compan y has delivered the goods, performed the services or title has change hands and cash or cash equivalent has already been received. For revenue to be realizable, the company would have performed all the necessary requirements to receive the  payment in the future.

The principle stated above was violated by the $7.8 million barter transaction because the company is receiving trade credits. It is unclear as to the value and the usefulness of these trade credits thus it is hard to measure the monetary value this have to the company. If they are unable to value what was received, it would be harder for the company to say the amount that can be realized. The two consignment case violated ASC 605 because title did not change hands. Inventory on consignment means that North Face still owns the inventory, title did not change hands and the company cannot recognized any revenue from this consignment until the goods have been sold to 3rd parties.

4. Audit work papers are a very important part of the audit engagement because it provides documentation and analysis of all audit findings. AU-C Sec. 230 states that the principal objective of audit work papers is to provide supporting evidence of the auditor’s opinion on the financial statements based on audit findings and documentation during the audit engagement. The above objective was undermined by Deloitte when they decided to alter North Face’s work

 papers for 1997 because they are altering and destroying the evidence that supported their 1997 opinion on the audit financial statements. This in turn would bring the question as to the reliability of the opinion given by Deloitte for the 1997 financial statement.

5. Auditors do not have the responsibility to assess the quality of key decisions made by client executive because as per AU-C Sec. 240.04, “The primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management.” As per the guidance, the company is the one responsible for preventing fraud and they are the ones that would take full responsibility of their key decisions. An independent auditor, regardless of how familiarized they are with their client’s industry, would not be able to have a complete understanding of the decisions made by the company’s management because every company,

even in the same industry, operates differently. Since auditors are unable to understand the strategic blunders fully, they will be unable to access the quality of the key decisions of key executives.