Auditing Case Study DO NOT RESPOND IF YOU HAVE NOT READ AND SEEN THE REQUIREMENTS!
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It’s not a secret anymore! – People's Republic of China company and audit firm collide
ABSTRACT
This case is based on actual occurrences and requires students to apply auditing concepts and
professional standards in an international setting. An affiliate of a U.S. accounting firm, Loxon
Shanghai CPA Ltd., has received a request from the SEC for the audit workpapers of one of their
Chinese clients, Great Lead Software. If Loxon complies with the SEC, they may violate Chinese
State Secrecy Laws. After revelations of fraud by Great Lead Software surface, Loxon’s decision
regarding the workpapers becomes more perilous. The case provides an opportunity for students
to achieve multiple learning objectives including: identifying audit deficiencies in a global setting,
describing the steps taken by the PCAOB when conducting an inspection along with the possible
sanctions, identifying the Critical Audit Matters and preparing an audit report in accordance with
the recently adopted AS3101 and AS3105 standards, describing how culture may affect financial
reporting systems including transparency and regulatory issues, and identifying the potential
conflicts between the U.S. regulatory requirements and their implications on auditors’ liability and
responsibilities towards third parties.
Keywords: Audit Workpapers; Sarbanes-Oxley Act; PCAOB; fraud; SEC Section 10A;
Chinese State Secrecy Laws.
The Case
Based in Shanghai, China, Great Lead Software (GLS) provides software solutions for many types
of industries including manufacturing, banking, and insurance. While GLS offers many types of
software, supply chain management, inventory management, and accounting solutions software
provide the three largest sources of revenue. GLS began operations four years ago and had been
very successful in terms of income and sales growth.
Mr. Cheng Lin is the Chairman of GLS and has been with the company since its inception. Within
just two years after GLS began operations, Mr. Lin was successful in having GLS listed on the
New York Stock Exchange (NYSE). However, in the same year that it was listed on the NYSE,
GLS abruptly changed auditors. This change occurred amid rumors of a confrontation between
Mr. Lin and GLS’s Audit Committee over fraud allegations. The catalyst of the allegations were
financial analysts’ observations that GLS’s cash balances and profitability ratios were high relative
to industry averages.
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Upon the resignation of its auditor, GLS filed a form 8-K with the SEC citing the resignation. The
8-K indicated the resignation was the result of scope limitations and loss of confidence in GLS’s
Board of Directors. The report also indicated that prior to their resignation, the auditor encountered
difficulties in authenticating cash confirmations received from GLS’s banks.
The 8-K also reported GLS’s Audit Committee had approved the appointment of a new auditor,
Loxon Shanghai Ltd. (Loxon). Loxon is a professional services firm that provides audit,
consulting, IPO support, and financial advisory services to clients in the Peoples’ Republic of
China (PRC). Within the PRC, Loxon services multi-national enterprises as well as a rapidly
growing number of Chinese business entities.
The transition from GLS’s predecessor auditor to Loxon was accelerated as to not jeopardize
GLS’s listing on the NYSE. One of Loxon’s engagement partners, Mr. Frank Harrison, performed
a cursory review of the predecessor auditor’s workpapers, but had no direct correspondence with
the former auditor. Mr. Harrison also reviewed GLS’s financial statements and met with the Audit
Committee. Despite some lingering concerns, Mr. Harrison recommended that GLS be approved
as a new client for Loxon.
Loxon is among the leading firms providing services to clients in the PRC. Loxon is an affiliate of
a large US audit firm which employs thousands of professionals worldwide. Loxon itself employs
over 100 employees, including staff accountants, senior accountants, managers, senior managers,
and partners, along with administrative staff. Many of Loxon’s staff and senior accountants have
less than five years’ experience, which is common among many CPA firms. The managers and
partners usually have at least seven years of experience. Besides ensuring audits are in compliance
with applicable laws and standards, engagement partners are also responsible for evaluating
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potential clients. Upon recommending GLS’s approval as a new client, Loxon assigned Mr.
Harrison as its engagement partner.
Mr. Harrison had been a partner with Loxon for just over four years when he was assigned to the
GLS account. Prior to his time at Loxon, Mr. Harrison had lived in Washington, D.C. where he
worked for Loxon’s parent firm. Loxon had been experiencing difficulty retaining employees at
the partner level so Mr. Harrison was asked to transfer from the parent firm’s D.C. office to the
Loxon office in Shanghai. Along with his wife and son, Mr. Harrison decided to make the move
as it would be a great experience for the entire family.
In the two years since GLS was listed on the NYSE and hired Loxon as its auditor, their market
valuation continued to grow, but some financial analysts were still questioning several of GLS’s
financial statement items. Specifically, when compared to industry norms, GLS’s reported sales
and cash balances were excessively high while several expense accounts, including cost of goods
sold, were low relative to sales. Analysts were also beginning to question some of the debt
information in GLS’s most recently published financial statements. Fueling these suspicions were
persistent rumors regarding the abrupt resignation of GLS’s former auditor. These rumors
suggested that GLS refused to provide the former auditor with original invoices that supported the
growing sales and cash balances and that GLS management interfered with third-party
confirmation processes.
The growing suspicions over the legitimacy of GLS’s financial statements prompted the Securities
and Exchange Commission (SEC) to request GLS’s audit workpapers from Loxon. The SEC’s
request for GLS’s workpapers is in part guided by The Sarbanes-Oxley Act (SOX). SOX has had
a profound effect on both U.S. and foreign issuers that are listed on the U.S. markets, as well as
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their auditors. For instance, foreign public accounting firms1 that perform audit work for any public
issuers listed on the U.S. markets are subject to SOX. Specifically, Title 1, Section 106 of SOX
states that Foreign Public Accounting Firms that issue an audit opinion are deemed to have
consented:
(A) to produce its audit workpapers for the Board or the Commission in connection with any
investigation by either body with respect to that audit report; and
(B) to be subject to the jurisdiction of the courts of the United States for purposes of enforcement
of any request for production of such workpapers.2
Responding to the SEC’s request for the GLS workpapers created a dilemma for Loxon. While
Loxon was under the jurisdiction of SOX, they were also under the jurisdiction of Chinese law.
Of particular concern to Loxon was the fact that by providing the GLS workpapers to the SEC,
they could be in violation of China’s “State Secrecy Laws.” According to the Criminal Law of the
People’s Republic of China3, Chinese companies are prohibited from disseminating information
that are deemed to be state secrets. In addition to the State Secrets Law, other Chinese laws overlap
and provide more protection for private data including the Criminal Law, Tort Liability Law, and
the Anti-Unfair Competition Law. Companies conducting business in China are required to
comply with these laws as together they provide legally binding protection against data
infringement. For example, the Chinese State Secrecy Law has criminal implications for “whoever
steals, spies into, buys, or unlawfully supplies state secrets or intelligence for an organ,
organization or individual” based on Article 111 of the Criminal Law and Security Law in China.
Unauthorized sharing of state secrets subjects individuals as well as firms to penalties ranging from
1 Foreign Public Accounting Firm is a public accounting firm that is subject to the laws of a foreign government or
jurisdiction. 2 https://www.congress.gov/bill/107th-congress/house-bill/3763/text 3 http://english.court.gov.cn/2015-12/01/content_22595464_9.htm
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public surveillance and deprivation of political rights to imprisonment and even the death penalty
for severe cases that involve violations of National Security Act of the People’s Republic of
China.4
Although the scope of information that is considered a state secret is mostly limited to specific
categories such as national defense, foreign affairs, and energy resources, the law also includes a
broad category “other matters” that are classified by the State Secrets Bureau. This provision gives
Chinese authorities the right to retrospectively classify any matter as a state secret. This ambiguity
gives lawmakers in China the ultimate discretion to classify information as state secrets, thus
creating significant compliance and risk management challenges for any company conducting
business in China.
In considering the conflicting expectations of the SEC and the PRC, Loxon decided to withhold
GLS’s workpapers from the SEC. Loxon’s partners were concerned that turning the workpapers
over to the SEC was too risky considering China’s State Secrecy Laws. While Mr. Harrison agreed
with the other partners about this decision, he was concerned that noncompliance with the SEC
could cause detrimental harm to Loxon.
Loxon’s decision to withhold the workpapers was not unusual. Indeed, the SEC has had difficulty
in getting PRC firms that are listed on the U.S. stock exchanges to comply with the SOX and
PCAOB requirements. This issue was recently brought to the attention of the U.S. Senate by SEC
Chairman Jay Clayton. As a result, the U.S. Senate passed the Holding Foreign Companies
Account Act in May 2020 that would authorize the SEC to remove any PRC firm whose auditor
is not inspected by the PCAOB. If passed by the U.S. House of Representatives, this bill is
4 https://www.kwm.com/en/uk/knowledge/insights/china-investigations-handling-state-secrets-and-privacy-data-
20150910
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expected to bolster the SEC’s efforts to enforce PRC firms’ compliance with the U.S. laws and
regulations.5
The SEC’s request, coupled with the continuing questions from financial analysts’ regarding the
legitimacy of GLS’s financial statements, prompted several investors to voice their concerns to
both GLS’s Board of Directors and to Loxon. According to GLS’s most recent balance sheet, cash
accounted for more than half of the company’s total assets. Investors were questioning why the
amount was so high and whether it existed at all. In addition, Loxon had recently received
additional information that proved to be troubling. As Mr. Harrison described, “[i]t was strongly
suggested that we re-confirm the bank balances.” He continued, “[i]t was not until we sent a few
of our auditors to several of the banks when evidence of cash fraud surfaced. Several of the bank’s
employees confirmed they had known that the bank confirmations were misstated.”
With these concerns and the revelation of potential fraud, Mr. Harrison requested a meeting with
GLS’s Chairman, Mr. Lin. Mr. Lin was aware of the recent audit issues along with the SEC’s
request for the audit workpapers and agreed to meet with Mr. Harrison. The two men had just
entered a Loxon conference room in Shanghai and the tension was already high. Mr. Harrison was
angry about the allegations of fraud while Mr. Lin was visibly uncomfortable as he knew he was
going to share some troubling information. They had been discussing and at times arguing about
many of the key audit issues. The meeting was difficult for both parties, but
Mr. Harrison became increasingly troubled as the meeting progressed. The conversation
culminated with this pivotal dialogue:
5 Silvers, R. 2020. China Doesn’t Want to Cooperate with U.S. Regulators. Congress is Raising the Stakes. Barron’s.
https://www.barrons.com/articles/china-doesnt-want-to-cooperate-with-u-s-regulators-congress-is-raising-the-
stakes-51591986801
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Mr. Harrison: “I want to clarify what I just heard; could you please repeat what you said?”
Mr. Lin: “Well, the allegations are unfortunately true to some extent. I just had a meeting with
our internal auditors who confirmed that we have some issues with our financial
statements….too much “unverified” cash, overstated revenues and perhaps more…to give you an
idea about the figures we discussed in this meeting so far, cash and revenues are overstated by
50% and 40% respectively over the past two years and expenses are understated by 10% over the
same time period.”
Mr. Harrison: “This is very serious. You are telling me that individuals in your company have
committed fraud but you are making general statements without providing any details. Provide
specifics.”
Mr. Lin sat there silently for a few moments, so Mr. Harrison continued.
Mr. Harrison: “Who changed the cash amounts? Who provided the fraudulent revenue
amounts?”
Mr. Lin: “Senior Management.”
Mr. Harrison: “How long have you known about this? I need the names of everyone involved.
How far back does this fraud span?”
Mr. Lin: “Perhaps two to three years.”
Mr. Harrison: “I scheduled this meeting to discuss some of the issues we were encountering
during the audit, as well as discuss some of the rumors your investors have communicated to
me. I had some concerns but had no idea these issues were at the level you are stating. Do you
realize what will have to happen next? Do you?”
Mr. Lin remained silent, with his head lowered, and slumped into his chair.
Mr. Harrison: “We need to conclude this meeting, and I expect you will not speak to anyone
outside of your upper management regarding this meeting, if you speak to anyone at all.”
The meeting ended abruptly with Mr. Lin quickly leaving the building without saying another
word. Mr. Harrison realized he needed to work on damage control. That was the beginning of the
end. The concerns voiced by the analysts and investors were being confirmed by Loxon. The
financial statements illustrate the pattern of results that concerned both investors and analysts for
the past three years. The financial statements are included in Appendix A.
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Audit firms will include a statement in their client contract that gives the firm permission to
withdraw from an engagement if certain situations arise, such as finding any material discrepancies
that cannot be resolved. Such was the case here. The combination of financial statement fraud and
Mr. Lin’s admission that GLS senior management was involved, led to Loxon’s decision to resign
as GLS’s audit firm. Loxon’s resignation letter sent shockwaves through the financial community,
as this letter was subsequently posted online in its entirety. According to Mr. Harrison, all the key
parties at Loxon agreed that they had exhausted any hope of a positive resolution with GLS.
Loxon’s resignation letter, which is presented in Appendix B, provides more details about the
circumstances leading to the resignation.
Following Loxon’s resignation, GLS was unable to file an annual report for the most recent year.
The lack of audited financial statements coupled with the SEC’s investigation into GLS, resulted
in the following decision by the SEC: “It is ordered that, pursuant to Section 12(j) of the Securities
Exchange Act of 1934, the registration of each class of registered securities of GLS is hereby
REVOKED. GLS is not permitted to trade on the NYSE effective immediately.”
That was the final day of trading on the NYSE for GLS. At the height of the company’s trading,
GLS had been valued at over 2.4 billion U.S. dollars. When trading ceased, the company’s
valuation quickly dropped to 1 billion. Shortly thereafter, the stock was deemed to be worthless.
Actual revenues and net income were most likely a small fraction of what was reported. The fact
that GLS had significant debt meant that whatever assets remained would be liquidated and
distributed to the creditors, leaving investors out of the distribution.
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This result was difficult for many investors to fully understand, given the fact that GLS was
initially underwritten by several highly regarded global financial institutions. Just one month prior
to Loxon’s resignation, an analyst from one of these institutions reported that while fraud
allegations had arisen, GLS management firmly denied these allegations. “Our analysis of margins
and cash flow gives us confidence in GLS and the company’s accounting methods. We believe it
provides a good entry point for long-term investors.”
In reality, GLS management had already begun to panic prior to the meeting between Mr. Harrison
and Mr. Lin. In an effort to ease analyst and investor concerns, just four weeks prior to Loxon’s
resignation, GLS announced a plan to repurchase $50 million of their own stock. As weeks passed
and the company had not yet repurchased any shares, GLS’s CEO Mr. Kakawin was forced to
respond. He stated “the company has some very good news that we have not yet released, but we
were advised by our securities counsel that we should not be in the market purchasing our own
shares as this may be considered insider trading.” Mr. Kakawin’s “good news” was never shared
with the public.
GLS was not the only Chinese company that was under investigation by the SEC. Indeed, a total
of twenty-four PRC companies and five PRC audit firms were under investigation for possible
fraud. Similar to the suspicions surrounding GLS, a number of U.S.-based financial analysts who
were following the PRC companies alleged that assets were likely a small fraction of what was
claimed in their SEC filings. Allegations also included significantly understated debt and the
overstatement of both revenues and cash.
Although they were affiliated with major international audit firms, Loxon and the four other PRC
audit firms who were now under investigation by the SEC had never been inspected by the Public
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Companies Accounting Oversight Board (PCAOB)6. The PCAOB works in parallel with the SEC
to regulate the U.S. markets. Specifically, the PCAOB investigates audit conduct and the SEC
investigates public companies. While SOX requires inspections of accounting firms that audit
companies with securities traded in the U.S., the PRC had refused to allow these inspections.
The SEC eventually filed lawsuits against Loxon and the other four PRC audit firms. In
accordance with Title 1, Section 106 of SOX, (Foreign Public Accounting Firms) the SEC charged
all five accounting firms with violating U.S. securities laws by failing to turn over the audit
workpapers for inspection. The fallout from these lawsuits could be overwhelming. If the courts
rule in favor of the SEC, any PRC-based auditor that does not comply with SEC’s requests for
information could be barred from auditing companies listed on the U.S. exchanges. Such barring
could, in turn, make it very difficult for PRC companies to find SEC-compliant auditors.
Two years after Loxon resigned from the GLS audit, the SEC and the PRC audit firms under
investigation finally reached a settlement. The SEC levied significant penalties on the five PRC
based auditors, including Loxon, for their failure to comply with SOX, the SEC, and PCAOB
requirements. Each firm was censured, required to pay $500,000, and ordered not to issue any
audit report, accept any audit engagement, or engage in a substantial manner in preparation of any
audit report to U.S. public issuers or foreign-based firm that files with the SEC for six months. As
part of the settlement, the PRC firms also signed a Memorandum of Understanding (MOU) in
which they agreed to cooperate and be more transparent in the future.
6 The Sarbanes-Oxley Act of 2002 gave the PCAOB the authority for standard setting of the auditing industry.
Registered public firms in the U.S. market must comply with applicable auditing and related professional practice
standards including ethics and independence (PCAOB Rule 3100).
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The Case Requirements
Requirement 1
From the time that Loxon became GLS’s auditor, there were several audit deficiencies. Please
identify and describe the key audit deficiencies that led to GLS’s persistent financial statement
fraud.
Requirement 2
Section 10A of the SEC Act of 1934 requires auditors to report to the SEC when, during an audit,
an auditor detects: 1) illegal acts which have a material impact on the financial statements, and 2)
appropriate action is not taken by management and the board of directors. Loxon had
responsibilities to GLS, but also to other stakeholders, such as the SEC, the PRC, and investors.
Do you believe that Loxon fulfilled their responsibilities to each of the four stakeholders
mentioned?
Requirement 3
The PCAOB and SEC coordinate their efforts to ensure public firms’ compliance with their rules
and regulations and to protect investors. Section 106 of the Sarbanes-Oxley Act of 2002 requires
that auditors of a U.S. issuer registered with the PCAOB consent to produce workpapers when
requested by either the SEC or the PCAOB. Among the common investigations by the PCAOB is
the failure to cooperate with an inspection or investigation. Likewise, Rule 102(e) of the SEC
“Improper Professional Conduct” gives the SEC the power to sanction auditors if there is
professional misconduct.
a) What are the steps of conducting an inspection by the PCAOB?
b) What are the implications of violating the PCAOB inspections rules (types of sanctions) and
discovery of audit deficiencies on Loxon?
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c) Under SEC – Rule 102(e), what are the implications to Loxon for improper professional
conduct?
Requirement 4
In 2017, the PCAOB issued a new auditing standard to replace a portion of AS 3101 “The Auditor's
Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion”
and extended it with AS 3105 “Departures from Unqualified Opinions and Other Reporting
Circumstances”. The purpose of the new standards is to expand auditor reporting and enhance its
relevance to investors. AS 3101 is effective for audits of fiscal years ending on or after June 30,
2019 for large accelerated filers and on December 15, 2020 for all other firms. Please review the
final ruling of the AS 3101 using this link “https://pcaobus.org/Rulemaking/Docket034/2017-001-
auditors-report-final-rule.pdf” and answer the following questions:
a) Summarize the improvements in the expanded auditor report.
b) Define Critical Audit Matters (CAMs) and give examples from the present case.
c) Assume that Loxon had provided its last auditor report prior to resigning. Given the
circumstances of this case, prepare Loxon’s last audit report in accordance with the new
audit report standard AS 3105: Departures from Unqualified Opinions and Other
Reporting Circumstances. You may refer to an example of auditor’s report that you can
access through the PCAOB website by following this link:
https://pcaobus.org/Standards/Auditing/Pages/AS3105.aspx
d) What are the implications of this new standard on the case study?
Requirement 5
Culture can be defined as: “the collective programming of the mind that distinguishes the members
of one group or category of people from another” (Hofstede, 2001, p.9). According to Geert
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Hofstede’s cultural model, societal values are affected by ecological values and influenced by
external forces (trade and investment), and hence affect the business environment.
a) Describe the likely effects of the 6-D model of Geert Hofstede’s cultural dimensions on the
development of financial reporting systems within the United States versus China. The link
to the 6-D model of national culture by Geert Hofstede is shown below:
https://geerthofstede.com/culture-geert-hofstede-gert-jan-hofstede/6d-model-of-national-
culture/
b) Why are the financial statements in China considered State-sensitive information, while in
the U.S. they are public information?
c) Countries all over the world are categorized by their regulatory and political systems,
emerging as either common law countries, code law countries or mixed systems. Please
describe the regulatory and political systems of the United States versus China.
Requirement 6
a) What are the most significant implication(s) of China’s State Secrecy Laws regarding the
audit procedures and audit liability?
b) Do you think that Loxon was justified in their initial reluctance to provide the workpapers
to the SEC?
c) Was the SEC justified in their reaction? Please support your answers.
d) Roger Silvers is an accounting professor at the University of Utah and had served as a
visiting economist with the SEC. Professor Silvers recently wrote a comment letter to the
SEC that includes recommendations for the SEC to follow in an effort to reduce the risks
that investors face when investing abroad. The Comment Letter can be accessed via this
link: https://www.sec.gov/comments/emerging-markets/cll9-7328594-218510.pdf. Please
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read the letter and explain which course(s) of action would be most effective in reducing
risk when investing abroad.
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APPENDIX A – FINANCIAL STATEMENTS
Great Lead Software (GLS)
Income Statement For the year ended December 31, XX (in Millions)
20X1 20X2 20X3
Sales 258,900 129,450 64,725 Cost of Goods Sold (90,100) (35,000) (25,400) Gross Profit 168,800 94,450 39,325
Operating Expenses: Selling Expenses: Selling Expenses 5,600 2,800 1,400 Advertising Expense 8,600 4,300 2,150 Sales Salaries Expense 5,800 2,900 1,450
(20,000) (10,000) (5,000) General and Administrative Expenses Office Salaries Expense 24,500 17,150 15,435 Office Supplies Expense 2,255 1,579 1,421 Accounting and Legal Fees 4,720 3,304 2,974 Depreciation Expense 3,655 2,558 2,302
35,130 24,591 22,132 Total Operating Expenses (55,130) (34,591) (27,132)
Operating Income 113,670 59,859 12,193
Other Revenue/Gains/Losses Interest Income 2,200 1,450 1,305 Interest revenue 1,500 2,570 2,313 Gain on Disposal of Plant Assets 25,000 14,810 13,329 Unrealized Gain on Trading Investments 6,500 7,270 6,543 Loss on Asset Impairment 2,850 1,840 1,656 Total Other Revenue/Gains/Losses 32,350 24,260 21,834
Income from Continuing Operations 146,020 84,119 34,027 Income Tax Expense (85,110 × 40%) (58,408) (33,648) (13,611)
Net Income 87,612 50,471 20,416
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Great Lead Software (GLS) Balance Sheet
As of December 31, XX (in Millions) 20X1 20X2 20X3
Assets
Cash 60,000 54,000 38,200 Accounts Receivable 25,000 22,500 13,500 Inventory 10,500 9,450 5,670 Prepaid Insurance 6,800 6,120 3,672 Property Plant and Equipment 15,000 13,500 8,100 Less: Accumulated Depreciation (680) (612) (367) Total Assets 116,620 104,958 68,775
Liabilities and Shareholders' Equity Accounts Payable 900 2,900 4,350 Other Current Liabilities 3,500 4500 5,000 Income Taxes Payable 3,080 2,772 6,500 Notes Payable—long term 200 2,050 7,100 Common Stock 26,780 27,792 19,500 Retained earnings 82,160 64944 26,325 Total Liabilities and Stockholders’ Equity 116,620 104,958 68,775
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APPENDIX B - BY EMAIL AND REGISTERED MAIL
The Audit Committee Great Lead Software No. 155 Tangzue Road Shanghai, Jiangsun Province People’s Republic of China
Attention Mr. Song, Chairman of the Audit Committee
During the audit of the Company’s financial statements for the most recent year, it was determined that, regarding the bank confirmations, it was proper to complete additional visits to the main banks. These audit steps reported some very grave issues including: substantial differences regarding deposit balances reported by the bank compared with the amounts in the bank reconciliations, reports by the bank employees that their bank had no record of some of the transactions; and significant borrowings reported by the bank employees not recognized in the bank confirmations.
Further, it has come to our attention that the confirmation process was abruptly halted, as several troubling incidents occurred. Calls to the banks from Great Lead Software (GLS) indicating that Loxon was not their audit firm were made, confiscation by GLS staff of all second-round bank confirmation documentation, intimidations to prevent the audit staff from leaving GLS premises unless GLS was able to keep the Loxon audit files, and confiscation by GLS of Loxon working papers.
Regarding this development, we contend that you immediately return our documents.
We bring these substantial issues to your attention in the context of the audit responsibilities under Statement on Auditing Standards AU-C 240 (formerly SAS No. 99) “Consideration of Fraud in a Financial Statement Audit” issued by the American Institute of Certified Public Accountants.
The motives for our resignation include: 1) the intentional interference by the GLS management in our audit process, 2) the illicit confiscation of our audit files, and 3) the recognized falsification of GLS financial records related to cash, revenue, and loan balances. These recent issues weaken our capability to rely on the representations of the GLS management which is a vital element of the audit process; hence our resignation.
We have also reached the decision that we are no longer able to place reliance on management representations relative to prior period financial statements. Accordingly, we request that the company take prompt actions to make the necessary 8-K filing to state that continuing reliance should no longer be placed on Loxon audit reports on the previous financial statements and we refuse to be associated with any of GLS’s financial communications during the three most recent years.
We also agree to a copy of this letter being provided to the SEC and the subsequent auditor to be selected.
In our view, the events described in this letter could constitute illegal acts for purposes of Section 10A of the Securities Exchange Act of 1934. Accordingly, we remind the Board of its obligations, including the notice obligations to the U.S. SEC. You may consider obtaining legal advice on this matter.
Sincerely,
Loxon Shanghai CPA Ltd. cc: The Board of Directors
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REFERENCES
Criminal Law of the People's Republic of China. The Supreme People’s Court of the People’s
Republic of China. Available at: http://english.court.gov.cn/2015-
12/01/content_22595464_9.htm.
Public Company Accounting Oversight Board. (2003). Rule AS 3100: Compliance with
Auditing and Related Professional Practice Standards. Available at:
https://pcaobus.org/Rules/Pages/Rule_3100.aspx
Public Company Accounting Oversight Board. (2017). Rule AS 3101: The Auditor’s Report of
an Audit of Financial Statements when the Auditor Expresses an Unqualified Opinion
and Related Amendments to PCAOB Standards. Available at:
https://pcaobus.org/Rulemaking/Docket034/2017-001-auditors-report-final-rule.pdf
Sarbanes-Oxley Act Title 1, Section 106, U.S. Code § 7216 - Foreign public accounting firms.
Available at: https://www.congress.gov/bill/107th-congress/house-bill/3763/text
Silvers, R. 2020. China Doesn’t Want to Cooperate with U.S. Regulators. Congress is Raising
the Stakes. Barron’s. https://www.barrons.com/articles/china-doesnt-want-to-cooperate-
with-u-s-regulators-congress-is-raising-the-stakes-51591986801
Securities and Exchange Commission (SEC) Section 10 A. Section 10A of the Securities
Exchange Act of 1934, 15 U.S.C.§ 78j-1. Audit requirements. Available at:
https://www.sec.gov/rules/final/34-38387.txt