Accounting Theory

8 August 2016

1) BDO Seidman’s attorney pointed out correctly that professional standards do not prohibit auditors and client personnel from being ‘friends’. At what point does such relationship result in violation of the auditor independence rules and guidelines? Provide hypothetical examples to strengthen your answers. Health Management, Inc. was a pharmaceutical sales company who faced many problems after their fiscal year ending on April 30, 1995. They had issues surrounding an in transit inventory problem that totaled up to $1. 8 million.

Involved in the problem was an independence problem with their auditors. If the relationship goes beyond just social friendship, then there’s a problem. In the copy of the AICPA code of conduct, there is not a part that says that an auditor may not be friends with an audit client. 2) According to court testimony, on July 20, 1995, Drew Bergman recommended to HMI’s boards of directors that Mei-ya Tsai be hired as the company’s chief accounting officer (CAO). One week later, BDO Seidman issued its audit report on HMI’s 1995 financial statements.

Accounting Theory Essay Example

Under presently existing professional standards, would this situation have presented an independence ‘problem’ for BDO Seidman? Defend your answer. Professional accounting standards do not specifically state what is considered “friends”. This issue is highly controversial because there is not a defining point to where the independence issue is clearly seen. There comes a point to where a company and their auditors should not have a relationship. The point that I feel is the line that shouldn’t be crossed is if there is a relationship outside of the workplace.

When there is some sort of relationship to where a member of a company and a member of the auditing team see each other multiple times outside of work that is when there should be an independence issue. In this case I felt there was an issue. Tsia and Bergman had a pretty strong family relationship outside of work. Their families were friends and on occasion spent holidays together. When a relationship like this is happening one might have a problem telling the other one that their company is doing something wrong and causing them to lose millions of dollars.

The event where Bergman recommended Tsia to the HMI board for the CAO position would have cause an issue under present day standards. It would have cause an independence issue because the audit team and the company are not supposed to have ties between each other. In result of the Sarbanes-Oxley Act of 2002, there is a new provision that involves a “cooling off period”. This states that a company may not hire a member of the audit team before a certain time has passed. This helps keep auditor independence. 3) Under what circumstances is an inventory roll back typically performed?

How valid is the evidence provided by this audit procedure? Explain. An inventory rollback is performed when there is the possibility of an inventory issue of misstatement that could have material effect on the company’s financial statements. It usually occurs when the inventory audit occurs after the year-end date. The result of this procedure is reliable enough to authorize the inventory recorded by the client. If the amount from the rollback procedure is different from the balance in the client’s books then the auditors can then apply other procedures to reason the situation.

4) Jill Karnick abandoned her attempt to complete an inventory roll forward because of the considerable amount of work the procedure involved. Do you believe she made an appropriate decision given the circumstances she faced? How should auditors weigh the cost of an audit procedure, in terms of time and other resources, against the quality of evidence that it yields? In the event of the Jill Karnick roll forwards attempt, I feel she should have continued on with her procedure and finished it. There were plenty of red flags that she had noticed giving her a good enough reason to continue on with the procedure.

Since all the red flags would have probably had material effect on the records, she had every reason to go through with it. Because of time and costs, auditors may not be able to perform everything they can in the time period they have for the audit. When there is a possibility of material effect on a company the auditors need to do everything in their power to perform everything they can to detect the issue and be able to give their qualified opinion. 5) Should the result of inconclusive audit tests be included in audit work papers? Defend your answers.

Inconclusive audit tests should be included in the audit work papers. There are reasons that the auditors started the test and there are reasons why they did not finish the test, whether it because of lack of time and money or the auditor and company might be hiding something. If the inconclusive tests are included in the work papers, it might open eyes up for others such as in the case in the court room. 6)A major focus of the trial in this case was BDO Seidman’s consideration of, and respond to, the ‘red flags’ apparent during the 1995 HMI audit.

Define or describe the phrase ‘red flags’. Explain the impact of red flags indentified by auditors on each major phrase of an audit. The saying or term of “red flag” is defined as a warning signal and something that gives attention or provokes an irritated reaction. The impact of red flags identified by auditors should impact the audit greatly. It should help the audit procedure and what they need to look into and how much they should look into it. It may help auditors narrow down where the misstatements come from.

The detection risk may decrease for the auditors since they have a good idea that there are issues and possibly where the issues come from. It also may have the capability to decrease the cost of the audit because it may decrease the amount of procedures since they may not have to go in depth in some parts that do not have a red flag. 7) The PSLRA requires auditors to report to the SEC illegal act ‘that would have a material effect’ on a client’s financial statements, assuming client management refuses to do so.

Briefly describe three hypothetical situations involving potential illegal acts discovered by auditors. Indicate whether the auditors involved in these situations should insist that client management report the given item to the SEC. Defend your decision for each item. A situation where an auditor should contact the SEC about illegal acts is one similar to this case. If an auditor finds the hiding or the make-up of a large amount of inventory to intentionally misstate financial report and the company refuses to work with the auditor continuously avoiding the situation, insisting they are correct, etc.

then it is time to talk to the SEC. Another situation is if an auditor finds the top executives miss-reporting large amounts of payroll. The company may hide large amounts of cash illegally to avoid taxation or to increase profits. A third situation would be if the auditor sees that a company is not depreciating large warehouses, production plants, and other large assets that could cause material misstatements in their amounts of total assets. If the company refuses to work with the auditors in any of these situations then they should contact the SEC.

A limited
time offer!
Save Time On Research and Writing. Hire a Professional to Get Your 100% Plagiarism Free Paper