For each of the following independent scenarios, state the effect

For each of the following independent scenarios, state the effect

Subject: Business    / Finance    

Question

1) For each of the following independent scenarios, state the effect, if any, on each component of the audit risk model and explain why you made each selection including any "no effect" selections. For your answer to the "effect" portion of the question, select from I = increase, D = decrease, or N = no effect. I have included a table for each scenario to help you organize your answers and be complete.

a) In planning your audit and discussing various issues with management, you find out that they plan on issuing new stock in the near future.

Risk Model Component
    

Effect

(I, D, N)
    

Explanation

AAR
    

    

IR
    

    

CR
    

    

PDR
    

    

b) You client entered a new market for a new product they have never produced before. This product relies on cutting edge technology and also involves complex cost accounting transactions to cost the final product.

Risk Model Component
    

Effect

(I, D, N)
    

Explanation

AAR
    

    

IR
    

    

CR
    

    

PDR
    

    

c) The client's inventory turnover ratio rose dramatically from last year. They calculate this ratio using the original cost of the inventory before applying the lower of cost or market rule. Thus, it measures turnover in gross inventory, not net. Management cannot explain the change.

Risk Model Component
    

Effect

(I, D, N)
    

Explanation

AAR
    

    

IR
    

    

CR
    

    

PDR
    

    

d) The firm's management used excess cash to repurchase some of their outstanding stock during the audit year. This is not a new transaction for them and they have made stock repurchases in the past.

Risk Model Component
    

Effect

(I, D, N)
    

Explanation

AAR
    

    

IR
    

    

CR
    

    

PDR
    

    

e) The firm's management decided since they had grown large enough to afford to do so, they established an internal audit department during the year.

Risk Model Component
    

Effect

(I, D, N)
    

Explanation

AAR
    

    

IR
    

    

CR
    

    

PDR
    

N
    

Questions

1) You are a partner in a large local CPA firm and Peters, Inc., a medium-sized, private company, has asked you to do their audit. Peters, Inc. is not registered with the SEC and is not considering going public in the near future. It has about 300 shareholders locate in several states in the region where it is located. They have been audited in each of the last five years but haven't indicated why they are switching auditors.

Peters, Inc. makes air bags for cars. This is a highly specialized product and Peters uses a unique technology and involves a proprietary chemical combination to create the small explosion that deploys the air bag on impact. While their production process is unique and complex, their financial structure is simple. Their only sources of capital are their common stock, retained earnings, and some simple bank loans.

You and your firm currently are members of the AICPA. All the partners and managers are licensed CPAs in the state where Peters, Inc.'s main offices are located and they are also members of the AICPA. Your firm has limited experience with car parts manufacturing and none with air bag producers. However, your firm has offices that can cover the physical locations where the prospective client does business, all of which are located in the US.

a) Develop a checklist of five areas or issues that you would want to research before you accepted this firm as an audit client. For each area or issue, explain why you would want to research it and give an example of where you might go to get some information about each issue.

i) Issue 1 –

ii) Issue 2 –

iii) Issue 3 –

iv) Issue 4 –

v) Issue 5 –


b) Describe three organizations, boards, or groups that have legal authority to regulate aspects of your audit of this client and discuss how that organization, board, or group would regulate your work on this audit.


1) Your annual audit of Microhard, Inc. had the following issues:

· Even though Microhard, Inc. had significant long-term debt, all of which were bank loans secured by various fixed assets and some of which included restrictive covenants, you decided not to confirm the debt with the banks that issued the debt. You had auditing the firm for years and their balance sheet listed the same loans as last year, just reduced by the amount of the principle they paid during the year. However, management didn't tell you that the firm had incurred a major new loan to compensate for a significant drop in its operating cash flows. Thus, you ended providing a clean opinion on a set of financial statements that materially understated long-term debt.

· You were aware that all of the banks that had issued loans to Microhard, Inc. in the past required audited financial statements as part of their loan approval process.

· Shortly after you had issued your report, Microhard, Inc.'s cash flow problems continued to deteriorate. The tried to compensate in two ways. First, they took out another large bank loan from one of the banks that held other bank notes from the firm, using your audited financial statements as support for the loan. Second, they sold additional stock to raise additional capital. The used your audit financial statements in the prospectus they issued to support the new stock sale. Microhard, Inc.'s stock is publicly traded and subject to SEC regulation.

· Approximately six months after Microhard, Inc. executed both the new loan and the stock sale, they declared bankruptcy because their operating cash continued to deteriorate to the point they could no longer make the debt payments. Because of the bankruptcy, trading was suspended on Microhard, Inc.'s stock because its value had dropped by 98% and the banks could only recover 20% of the remaining balances on their loans.

· Both the bank that had issued the new loan and several major stockholders that had purchased stock from the new offering sued you to recover their losses.

Answer the following questions and justify your answers with specific references to the appropriate laws and legal principles. Be thorough in covering all the issues concerning both if they bank will prevail and what the auditor could prove to prevent that. To help shorten your answer a little, if the same logic would apply to more than one question, you can just refer back to that logic from a prior answer and not restate it.

a) Will the bank be successful in their law suit against you for:

i) ordinary negligence?

ii) fraud?

b) Will the stockholders who purchased their stock in the stock offering for which Microhard, Inc. used your audit financial statements succeed in against you under each of the following bodies of law?

i) Common Law

ii) Federal securities law (be sure to indicate which statue)

The following questions address fraud risk factors, the assessment of fraud risk, and the auditor's responsibility for detecting fraud. For each question, select the best answer and explain why it is the best answer. Also, cover why the alternatives are not the best answer. That is, your explanation needs to mention all four alternatives and address the strength of each in some way.

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