Complicated new computer system. The complicated system poses a couple of problems for the auditors. First, the auditors may have difficulty getting the information they need from the system, and a question arises regarding auditability. Second, inadequate controls over the new system may increase the amount of substantive testing required. Client hesitant to allow new auditor to speak with previous auditor. Anytime a client is hesitant or unwilling to allow new auditors to communicate with the previous auditor, a red flag should be raised in the mind of the successor auditor, and a careful examination of the issue, including consideration of management integrity, should ensue. Illegal gambling incident. This is a matter of concern because it raises the management integrity issue.
What the V.P. of finance did was definitely wrong, but the impact on the overall integrity of management is a matter of judgment. This issue can be debated among the students. Some will come down on one side saying that if a key member of management is dishonest in one thing, he is likely to be dishonest in others. Other students will argue that the incident has little to do with the business and its management, especially since there are no other known incidents. At a minimum, this incident creates an opportunity to raise and discuss the central role of management integrity in the client acceptance decision.
Initial public offering. Ocean has plans to go public and aggressively expand into the national market. If successful, these plans will make Ocean a more attractive client for Barnes and Fischer, but they also serve to increase the auditor’s business risk (increased reliance on the statements, increased litigation risk, etc.) and should be considered. Management’s aggressiveness. There are some indications in the case that management is willing to manipulate the financial statements via year-end accruals and revenue recognition to achieve relatively low interest rates from creditors. This raises a potential management integrity issue, and should be heavily weighted in view of the fact that the upcoming IPO may give management even greater incentive to manipulate the financial statements.
Relationship with predecessor auditor. This issue is left intentionally debatable in the case, but is certainly a concern that should be raised. The relationship with the predecessor auditor has been negative, and this is cause for concern. On the other hand, the poor relations may be present because the auditor did not have a sound understanding of Ocean’s business and was not competent in helping Ocean with its new IT system. Personality issues can also play a role. Further, the apparent differences over the current year’s audit fee should be a concern to Barnes and Fischer from a business perspective. Students should also raise positive non-financial issues, such as the opportunity to expand into a new industry and the opportunity to provide significant consulting services relating to Ocean’s new IT system as well as to Ocean’s internal controls. The company has a relatively long and stable history in the small appliances industry.
Further, Ocean is well positioned in the small appliances market. With its plans for going public and expanding nationally, the company may become an even larger and more attractive client. Some students will think the case represents a clear non-acceptance situation due to the negative factors listed above. The instructor can provide some perspective by pointing out that no prospective client comes without some concerns and problems. Ocean certainly presents some issues and concerns, but would likely be accepted by most auditing firms. (Two different partners from major firms commented in presenting this case to graduate auditing courses that the level of risk presented by Ocean Mfg. was fairly typical of many of the firm’s clients. In our experience, most students indicate that they would not accept Ocean Mfg. as a client. This case provides an opportunity for students to better understand the subjective issues and risks that auditors face in practice.).
Courtney from Study Moose
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