Litigation Support Review of Audit Essay
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The Runners Shop (TRS) was a family owned business founded seventeen years ago. TRS sold athletic footwear and related products for runners. TRS had four retail locations located in Charlottesville, Virginia; Richmond, Virginia; College Park, Maryland; and Cary, North Carolina. TRS had Net Sales of $2,217,292 and a Net Loss of $50,980 for 2004. TRS filed for bankruptcy protection in July of 2005 because of a cash shortage.
The cash shortage resulted from TRS’s inability to turn a profit, after four years of operations, with its three expansion stores (Richmond, Virginia; College Park, Maryland; and Cary, North Carolina).
TRS was required to have an audit of its financial statements to fulfill requirements of its loan agreements with First Commercial Bank and National Bank and Trust. Both lending institutions lost their outstanding loan balances when TRS filed for bankruptcy.
The annual financial statements of TRS were audited by Green and Brown, LLP for the last ten years. Green and Brown, LLP issued a standard unqualified opinion for TRS’s 2004 financial statements.
The two lending institutions jointly filed a lawsuit against Green and Brown, LLP alleging that it did not perform the audit in accordance with generally accepted auditing standards. The law firms representing the defendant and the plaintiffs are currently conducting discovery procedures.
USE OF CASE
Many students will have little conception of the objectives and purposes for documenting the audit work performed. This assignment works well in an undergraduate or graduate course when audit documentation is discussed. It is recommended that students complete this assignment prior to working on other assignments requiring the preparation of audit documentation.
A useful approach with this assignment is to review the objectives of each audit program step with students prior to asking them to complete the assignment “out-of-class.” More specifically linking audit steps to management assertions. This exercise reminds students that the audit work (and audit documentation) should support each management assertion. A worksheet for this “in-class” activity is provided at the back of the instructional notes.
A very lively class discussion tends to occur when students are asked to identify deficiencies they found with the audit documentation. This discussion provides an excellent opportunity to highlight the importance of good audit documentation (i.e., how seemingly minor mistakes, not relevant to a supposed audit failure, can in hindsight make a good auditor look incompetent). Some of the large public accounting firms have moved away from paper to electronic documentation of audit work. The nature of the changes in how audit work is being documented and the implications of these changes can easily be incorporated into the discussion of this case.
Cooperative learning activities can easily be adapted to this assignment. One activity for the preliminary “in-class” discussion would be Drill-Review Pairs (Pairs-Check). Students pair together and one student explains the management assertion for the first audit procedure while the other student checks the answer. The Roles for the next audit procedure are reversed, the answer checker for the first audit procedure explains the management assertion while the answer provider checks the answer. This basic process is continued until all procedures are answered. The instructor should walk around the class to ensure students stay on task. The cooperative learning activity of Homework Review can be used for the “out-of-class” assignment. Students meet in small groups to compare and discuss deficiencies they identified by schedule. After students have had a few minutes to compare and discuss their answers the instructor can randomly call on individual students to identify deficiencies they noted.
Relevant professional standards for this assignment are AU Section 230 “Due Care in the Performance of Work,” AU Section 326 “Evidential Matter,” AU Section 330 “The Confirmation Process,” and AU Section 339 “Audit Documentation.”
1. Describe the purposes of audit documentation and explain why each purpose is important.
Properly prepared audit documentation should provide 1) a basis for planning the audit, 2) a record of evidence collected and results of tests performed on the evidence, 3) a basis for determining the appropriate audit report and 4) a basis for review by supervisors of the work performed. Achievement of these four purposes aids the auditor in providing reasonable assurance that the audit was conducted in accordance with the auditing standards.
2. Review Green and Brown, LLP’s audit documentation guidelines and explain why an audit firm would want to include each of the listed items in its audit documentation.
The guidelines provided provide the following benefits: Title – Having a proper title helps individuals reviewing the schedule to quickly identify the client and schedule purpose. Source – Clearly identifying the source of a schedule helps to insure that appropriate testing of client prepared document occurs and facilitates planning for the next audit period. Work Performed – Clearing identifying who performed the work facilitates determination of follow-up questions that arise as well as planning for the next audit period. Indexing – Using a logical referencing system facilitates filing for later review as well as cross-referencing information between schedules. Tickmark – Providing explanations of the meaning of tickmark insures that the specific work performed is clearly documented.
3. Review the audit documentation prepared by Green and Brown, LLP, related to TRS’s Notes Payable and list deficiencies on the enclosed schedules.
A solution to the assignment is documented on a schedule similar to the schedule provided to students on the pages that follow. Note that a table linking audit procedures to management assertions is also provided.
4. Green and Brown, LLP would not be required to comply with the auditing standards of the Public Company Accounting Oversight Board (PCAOB) for the TRS audit because TRS is a private company. Setting this fact aside for the moment, go to the PCAOB Web site and review Standard No. 3, “Audit Documentation” (see http://www.pcaobus.org/Standards/index.asp). This standard requires that documentation of audit work contain sufficient information to enable an experienced auditor not involved with the engagement to achieve two objectives. What are those two objectives? Explain whether you believe the audit documentation in this case achieves these objectives.
The PCAOB “Audit Documentation” standard requires that the documentation be sufficient for an experienced auditor who had no association with the engagement be able to 1) understand the nature, timing, extent and results of the procedures performed, evidence obtained and conclusions reached and 2) determine who performed the work and the date such work was completed as well as the person who reviewed the work and the date such review occurred.