Auditing assignments

2-38. Hide-It (ID), a family-owned business based in Tombstone, Arizona, builds custom homes with special features, such as hidden rooms and hidden wall safes. Hide-It has been an audit client for three years.

You are about to sign off on a "clean" opinion on Hide'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’s 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 Hide'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

Deposits 1/17/X2 – 12/3/X4 $455,000

Interest earned 1/2/X2 – 12/31/X8 95,000

Withdrawals 2/12/X3 – 4/7/X7 (100,000)

Balance 12/31/X8 $450,000

Answer the following questions:

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?

Answer

(a) No, this is not an error since errors are unintentional.

(b) This situation does appear to involve misstatements due to misappropriation of assets. It is a misstatement due to fraudulent financial reporting because of the omission of the information from the financial statements. If the $100,000 withdrawals have been abstracted for personal use, the situation also involves a misstatement arising from misappropriation of assets.

(c) Certain laws have a direct effect on the financial statement amounts and are considered on every audit. An example is income tax law that affects the amount of income tax expense in the financial statements of most clients. This situation involves what appears to be non-compliance with a law that has a "direct effect" since, at a minimum; taxes have not been paid on the income involved.

(d) The auditors will need to consider whether withdrawal is necessary, perhaps after consultation with their attorney. The case suggests that the unrecorded deposits occurred prior to current management involvement with the company. Note, however, that interest was earned during the period this management has been with the company, and withdrawals have been made during this same period. The auditors would wish to consider when current management became aware of the account and the nature of the withdrawals when considering whether to resign from the engagement.

What you need to do

-Rewrite the answer is your own words and paraphrase it. Because it is taken from solution

-Write a very short summary of the answer after it is written in your own words – separated paragraph – indicated it

-Make sure you don’t copy anything from the answer