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Leslie Fay Case Essay

1. After reviewing the common size financial statements and the key ratios of Leslie Fay, there some of the financial statement item that should have been of particular interest to BDO Seidman:

1).Sales: the sales has been growing steadily except the slight drop in 1991, which is contrary to the industry recession.

2). Inventory: Leslie Fay has been known for not catching up the fashion, there should be inventory write-off issue in the apparel industry, which haven’t been reflected in the inventory account though.

3) A/R: always a highlight because of its nature of hiding fraud

4). Other assets account: the current and quick ratio of Leslie Fay is significantly higher than the industry norm.

5). Liability account: A/P and debt, to see if understated.

2. Other financial info that the auditor might have obtained:

1). The contract or agreement of Leslie Fay and department stores to verify the A/R and liability

2). Documentation with its customer regarding its orders

3). Its credit and bad debt write-off policy

3. Non-financial factors the auditor should consider:

1). The industry

2). Impact of economy on this particular industry and company

3). The company’s structure, history and personnel

4). Government regulations that have influenced or will show the effort on the company

4. Paul Polishan’s dominance has two-fold implications on the audit:

1). Suppose he’s a morally-impeccable person who did everything right and held high integrity and responsibility towards the company, his dominance still shows an internal control weakness which lack the segregation of duties. Such system is prone to the fraud and if Mr. Polishan is sick or absent from work for whatever reason, the finance department might not function well.

2). Mr. Polishan’s dominance explained the fraud he perpetuated and hid.

The audit should take this into consideration when planning the audit, Mr. Polishan’s dominance might indicate a weak internal control system, which should be evaluated at higher risk and more substantive test should be planned thereafter. The audit should also inquired more people, including other staff in the finance department and the company’s suppliers to verify the accounts rather than putting excessive faith in what Mr. Polishan has tried to have the audit believe.

5. SEC ruled that BDO Seidman’s independence was jeopardized because it’s been reckless in auditing the red flags shown in Leslie Fay’s financial statements.

J. B. Hanauer & Co Case

1. Receivables from customers and other brokerage firms usually accounts for 90% or more of a brokerage’s total assets, imposing the biggest internal control risk. The specific risks of J.B. Hanauer includes: the extensive responsibility of its sales staff. The auditor hasn’t sufficiently taken this into consideration and didn’t properly investigate these risks. Their doubts were allayed by the Hanauer’s response to the SEC sanctions.

2. Hanauer’s auditor sent out the confirmation letter to verify the existence of the account receivables and its dollar value.

1) For the first type of account which carries credit balances represented customers to whom Hanauer owed cash at year-end, the auditor objective is to verify the cash balance is right under the right name.

2) For the second type representing customers who owed cash to the brokerage firm, the auditor objective is to verify the firm’s not overstating it.

3) For the 3rd and 4th group, the risk is much smaller since there are little room for the firm to manipulate them.

3. For the accounts the client didn’t want confirm, the additional procedures may include: inquiry of the management and sales person, read documentations about these accounts and transaction history and resign if the client insists on not allowing them to confirm these accounts.

4. Material audit scope limitation is some actions from the client leading to the dollar value big enough to influence the user of its financial statements if not disclosed. I totally agree with SEC that Hanauer’s management imposed a material scope limitation on the audit because the dolar value of unmailed confirmation accounts for 18% to 26% of dollar value of accounts selected for confirmation, which is highly material.

5. The audit client should be allowed to “follow” its engagement audit partner to another accounting firm because it obviously breach the independence of the auditor after forging a relationship with the clients. SOX specified the “cooling-off” period for the auditor from entering the client management, this serves the same purpose as well.

Flight Transportation Corporation Case

1. Memo:

XXX, XX, 1980


With regards to the FTC’s 5.2 millions of air charter revenues from IAS, I didn’t find Rubin’s explanations convincing for lack of documentation for those transactions. Due to the highly materiality and nature of this transaction, I suggest us to further pursue those revenues for the proper documentation. I retain my opinion on this issue until the further evidence. Should we discuss this matter or bring it to the higher level, let me know.

Gregory Arnott

2. Measures accounting firms can adopt to lower risks that auditors will capitulate to their superiors when technical disagreements arise during the audit:

1) Internal control system that segregate duties, preventing the dominance of certain key employees

2) By-laws that prevent the right of staff from reporting to a higher level when identifying fraud

3) Regular review and evaluation of each staff

3. If I was the staff auditor who discovered the bogus air charter revenue, I assume I have the responsibility of bringing it to the attention of higher level. I would report to my immediate managers to discuss the further measures, if he refuses the further investigate, I’ll write a memo to dissociate myself from Harrington’s decision to accept those revenue.

4. Additional audit procedures applied to the 1981 FTC Cayman revenue include:

1) Confirmation or surprise visit to the Cayman ltd.

2) Review the documentation of contract with Cayman to identify the nature of the transaction

3) Have the FTC management provide a written memo explaining the revenue of related party transaction.

4) Research or analysis of the treatment of those related party transaction.

5.Flaws in the auditor’s confirmation procedure:

a) Went to Rubin to confirm the revenue from Cayman. He’s obviously not the right person to go.

b) Accepted Rubin’s explanation for the IAS revenue without the proper documentation.

c) No further evidence was intended to be achieved.

6. Other special risks of the audit: the weak internal control system, lack of documentation, industry recession, need of large capital to finance operation, concentration of revenue from one major customer.

7. Specific measures audit firms can take to ensure that client-imposed pressure does not adversely affect the quality of an independence audit:

1). Clearly define the responsibility and right in the engagement letter

2). Timely and proper communication with the client in terms of their expectation being too high or not

3). Working with the client’s audit committee to get through the problem rather than directly with client’s management

4). Resign if the pressure is excessive to the point that jeopardize the quality if the audit

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