Take a look at Case 8.1 and answer the following questions: Case 8.1 Audit Adjus

Question

Take a look at Case 8.1 and answer the following questions:

Case 8.1 Audit Adjustments:

You are a CPA on the audit staff of a multinational public accounting firm. You are the senior auditor on an annual audit of a manufacturing company that is a small subsidiary of a larger company that is a significant client of your firm. In addition to a sizable fee for the annual audit, the parent company pays your firm additional fees each year for tax consultation and return preparation as well as other management consulting services. With this particular audit, as with many parent-subsidiary relationships, you are aware that there is a tremendous amount of pressure on the subsidiary company’s management to reach certain projected sales goals for the year. Because of this, the climate at the subsidiary is tense as you begin your annual examination of the year-end financial statements. During the course of the audit, you perform a sales cutoff test to ensure that all sales transactions at year-end were recorded in the proper period. Since title to the company’s products passes when they are shipped to customers, shipments are required in order for a sale to be properly recorded. Accordingly, a standard audit procedure is to cross-reference sales recorded prior to year-end to related shipping records to sales journals. The sales cutoff test revealed that numerous shipments made after the company’s year-end were recorded as sales prior to year-end, which resulted in significantly higher revenue during the year you are auditing. You are aware that as an independent auditor, you have a responsibility to your clients and to those who might make decisions based on the company’s financial statement, such as investors and lenders. When you inform the subsidiary’s controller of the results of your sales cutoff test and that an adjustment to annual revenues and profits would likely be warranted, he takes the matter to the president of the subsidiary. During a follow-up meeting with the controller and president, the president attempts to get you to reconsider your proposed adjustment with the following arguments.

1) The amount of the adjustment you were proposing was not material to the parent company’s financial statement.

2) All of the subsidiary’s competitors did the same thing in recording shipments just after year-end as sales in the previous year.

3) It really didn’t matter in the long run if sales were moved from the current year to the next year, since sales and profits for the next year would be greater> At the end of the meeting, the president drops a not-so-subtle reminder that his company is a substantial client of the firm. You call the partner from your firm who is in charge of the audit for advice, and he tells you to handle the situation on your own. After considering all factors, you continue to feel that an adjustment to the company’s financial statements is warranted, but after a meeting with the client attended by your senior partner on the audit (and not attended by you) you are instructed by the senior partner not to make the adjustment.

How should you react?

Question answer should address these issues – This calls for an analysis that appreciates the complexity of the auditor’s role.

The well written answer will address the following points: The auditor and the auditor’s firm has to recognize that its own financial survival may be dependent in part on continued satisfactory work in the eyes of the client/subsidiary as well as that of the subsidiary’s parent corporation.

The auditor will have to reconcile professional and satisfactory service with the responsibility of the auditor to report accurately and to attest to proper accounting standards within the reporting system of the subsidiary.

The auditor will be subject to professional discipline and civil liability if the auditor fails to honor professional standards of conduct and of fiduciary duties.

As a practical matter, and as an interpretive artist, the auditor need not either comply with the senior partner or quit…

Information can be honestly presented in a fashion that is candid, such as through footnoting, while still presenting a picture that might me closer to the expectations of the client. Of course, there is a large potential for disingenuousness in such an approach.

Explanation / Answer

Auditors comment on the true and fair view of financial statements affect the decision of the shareholders and investors and hence the Auditor comment on the financial statements is of significant importance.

Since numerous shipments made after the company’s year-end were recorded as sales prior to year-end, which resulted in significantly higher revenue during the year you are auditing , adjustment will be made in the financial statements.

The Presidents view is considered but not accepted since:-

1) Amount of adjustment is materal since it resulted in significantly higher revenue during the year

2) What are being done by the competitors is of no importance since i as a Auditor is following the standards

3) Sales are not being moved from the Current year to next year instead It is moved from the next year to this year and the trend might follow

The above mentioned manufacturing Company is a subsidiary while the parent Company is the significant client of the firm. Disclosing the facts will be in the favor of the firm since if the parent company get to know about this thing, the firm might lose the parent company.

The Auditor firm in this way comply to the professional discipline and civil liability.

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