Case 5.5 KOGER PROPERTIES, INC.

I.

ANSWERS TO QUESTIONS
1. Given that Goodbread purchased stock of Koger Properties in
1998, under what conditions, if any, could he have later served
as the audit engagement partner for the company?
Holding a financial interest in an audit client may create a selfinterest threat. The existence and significance of any threat
created depends on: (a) the role of the person holding the
financial interest, (b) whether the financial interest is direct or
indirect, and (c) the materiality of the financial interest.
If other partners in the office in which the engagement partner
practices in connection with the audit engagement, or their
immediate family members, hold a direct financial interest or a
material indirect financial interest in that audit client, the selfinterest threat created would be so significant that no safeguards
could reduce the threat to an acceptable level.

Owning shares of stock in an entity is clearly a direct financial interest in the

entity.
Accordingly, section 602.02.b of the Codification of Financial
Reporting Policies (FRC) states that any stock ownership in a client impairs
independence, and that "materiality is not a consideration in the case of a
direct financial interest." However, it was not just his status as engagement
partner on the audit that caused a lack of independence, but also his status
as a partner of a firm that is the auditor of record for an SEC registrant. As
noted above, it is clear that a direct financial interest by any member of an
accounting firm would impair the firm's independence. The rule goes on to
say that "the term member means (i) all partners, shareholders, and other
principals in the firm."
Thus even if Goodbread had not been the
engagement partner for the Koger audit, his ownership of Koger stock was a
direct violation of the independence rule.
Codification of
Financial Reporting Policies (FRC) states that any stock
ownership in a client impairs independence, and that "materiality
is not a consideration in the case of a direct financial
interest."
2. During much of the nineteen century in Great Britain,
independence auditors were not allowed to have an equity
interest in their clients but were required to invest in their clients
in certain circumstances. Explain the rationale likely underlying

that rule. make sense in todays business environment in the

Unites States? Defend your answer.
3. The SEC charged that Goodbread violated its independence
rules, the AICPAs Code of Professional Conduct, and generally
accepted auditing standars (GAAS). Explain the SECs rationale in
making each of those allegations.
Violation of Commission's Independence Rules
Koger's financial statements were required to be audited by an independent
accountant for the fiscal year ended March 31,1990. "an accountant will be
considered not independent with respect to any person...in which...he, his
firm or a member of his firm had, or was committed to acquire, any direct
financial interest or any
material indirect financial interest..." Owning shares of stock in an entity is
clearly a direct financial interest in the entity. Accordingly, section 602.02.b
of the Codification ofFinancial Reporting Policies (FRC) states that any stock
ownership in a client impairs independence, and that "materiality is not a
consideration in the case of a direct financial interest." However, it was not
just his status as engagement partner on the audit that caused a lack of
independence, but also his status as a partner of a firm that is the auditor of
record for an SEC registrant. As noted above, it is clear that a direct financial
interest by any member of an accounting firm would impair the firm's
independence. The rule goes on to say that "the term member means (i) all
partners, shareholders, and other principals in the firm." Thus even if
Goodbread had not been the engagement partner for the Koger audit, his
ownership of Koger stock was a direct violation of the independence rule.
Violation of GAAS and Code of Ethics
The AICPA Code of Professional Conduct expressly prohibited Goodbread's
Koger stock ownership during the time of the Koger audit. The Code states
that "[i]ndependence shall be considered to be impaired if . . . during the
period of a professional engagement, or at the time of expressing an opinion,
a member or
a member's firm . . . [h]ad or was committed to acquire any direct or
material indirect financial interest in the enterprise."
If an auditor is not independent, "any procedures he might perform would
not be in accordance with generally accepted auditing standards and he
would be precluded from expressing an opinion on such statements."
Accordingly, under such circumstances, GAAS requires an accountant to
"disclaim an opinion with respect to the financial statements" and to "state
specifically that he is not independent."

Goodbread held a direct ownership interest in Koger stock while

participating in the initial phases of the audit of Koger's financial statements.
Notwithstanding this lack of independence from Koger, Goodbread caused
Deloitte & Touche to issue an unqualified audit report, contained in Koger's
Form 10-K for the fiscal year ended March 31, 1990, stating that Deloitte &
Touche was independent and that the audit was conducted in accordance
with GAAS. Under the circumstances, Goodbread's ownership of stock
specifically precluded any representation that the audit was conducted in
accordance with GAAS and required Goodbread to make sure that Deloitte &
Touche disclaimed an opinion on the financial statements and disclosed the
lack of independence.
Unethical and Improper Professional Conduct
Based on the foregoing, Goodbread engaged in unethical and improper
professional conduct by:
1. failing to immediately divest himself of stock ownership of an SEC
client when he became a partner of the merged firm;
2. violating GAAS by owning stock of a client during the time of an
audit engagement;
3. failing to inform his firm of his stock ownership in order to make
sure the firm disclaimed an opinion on the financial statements and disclosed
the lack of independence; and
4. causing his firm to issue an unqualified audit report on a client's
financial statements under these circumstances.
4. In your opinion, did Goodbreads equity interest in KOger
Properties likely qualify as a material investment for him? Was
the materiality that investment a relevant issue in this case?
*** In my opinion, I do not think Goobreads equity interest in
Koger Properties would likely qualify as a material investment
for him. In relation to the AICPAs Rule of Conduct Rule 101
states,financial interests that impair independence is that any
partner or professional employee of theaccounting firm, his or
her immediate family, or any group of such persons acting
together has afinancial interest exceeding 5% of a clients
outstanding equity securities or other ownershipinterests. When
Goodbread purchased 400 shares of Kogers stock in 1998, Koger
hadapproximately 25 million shares of stock outstanding. The

percentage of Goodbread ownershipin Kogers stocks is less than

5%.
No, Goodbreads equity interest in Koger Properties would not
qualify as a materialinvestment for him. According to SECs
Regulation S-X Rule 2-01, financial interests thati mpair
independence is that any partner or equivalent, professional
employee of the accountingfirm, or his or her immediate family,
or any group of the above persons has filed a Schedule 13Dor
13G with the Commission indicating beneficial ownership of more
than 5 % of a client'sequity securities (U.S. Securities and
Exchange Commission, 2010). On the other hand, underAICPAs
Rules of Conduct Rule 101, financial interests that impair
independence is that anypartner or professional employee of
the accounting firm, his or her immediate family, or anygroup of
such persons acting together has a financial interest exceeding 5
% of a clientsoutstanding equity securities or other ownership
interests (AICPA, 2010). These rules aresubstantially the
same.Accordingly, the term material investment does not
include ownership by any partneror equivalent, professional
employee of the accounting firm, his or her immediate
familymembers, or any group of the above persons of 5% or less
of a clients outstanding shares ofstock, equity securities, or
other ownership interests. For purposes of determining
materiality,the financial interests of the covered member and
immediate family should be aggregated(Knapp, Rittenberg,
Johnstone, & Gramling, 2011, p.94). Immediate family members
consist ofa spouse, a spousal equivalent, or dependents (Allen,
2001). In this case, Goodbread purchased400 shares of Kogers
common stock in December 1988. At the time, Koger had
approximately25 million shares of common stock outstanding.
The percentage of Goodbreads ownership in Kogers is far less
than 5 percent of Kogers outstanding common stock. Thus,
Goodbreadsequity interest in Koger Properties would not qualify
as a material investment for him

II.

CONCLUSION/RECOMMENDATIONS

Case 6.4 TOMMY OCONNELL, AUDIT SENIOR

I.

FACTS OF THE CASE

1. Tommy O'Connell had been a senior for only a short time before
being assigned to the Altamesa audit engagement.
2. Tommy wanted to impress his superiors and advance as rapidly as
possible within his firm.
3. Tommy was pleased when he learned of his assignment to the
difficult Altamesa engagement because it signaled that his superiors
highly regarded his work.
4. The Altamesa audit was a difficult engagement in part because the
company's
management took aggressive positions on key
accounting issues.
5. The Altamesa assignment required Tommy to be out of town for
several weeks, which did not make his wife happyshe had already
complained regarding the long hours he worked.
6. Tommy apparently did not like Carl Wilmeth and, as a result, was
upset when he learned that Carl would be his subordinate on the
Altamesa engagement.
7. The two seniors who Carl had worked for previously suspected that
he had signed off on audit procedures that he had not completed.
8. During the course of the Altamesa engagement, Tommy
suspected that Carl was not completing all of his assigned tasks.

9. Because he was so busy working on other matters during the

Altamesa engagement, Tommy did not take the time to investigate
his suspicions regarding Carls work.
10. Tommy never discussed his suspicions regarding Carls work with
the audit engagement partner.

II.

ANSWERS TO QUESTIONS
1. Now, assumed that Jack Morrison is reviewing the Altamesa work
papers. To date, you (Tommy) have said nothing to Morrison about
your suspicions regarding Carl, you have a professional
responsibility the responsibility to raise this matter now with
Morrison? Explain.
**** Yes, I have the responsibility to inform Morrison about my
suspicion regarding Carl because as a professional I should have
ethic to tell the fact or truth. According to rule 102- Integrity and
Objectivity. In the performance of any professional service, a
member shall maintain objectivity and integrity, shall be free of
conflict of interest, and shall not knowingly mispresent fact or
subordinates
2. Compare and contrast the professional roles of an audit superior
and staff accountant. In your analysis, consider the different
responsibilities assigned to each regarding the job-relates stresses
that individuals in the two roles faces, and how each role
contributes to the success and completion of an audit engagement.
Which of these two roles is (a) more important and (b) more
stressful? Defend your choices.
The role of an audit senior is more important. According to GAAS of
field work that auditor must adequately plan the work and must
properly supervise any assistant.
Auditor senior:
Lead client audit engagement
Obtain a thorough understanding of PCAOB and generally
accepted auditing standards, audit procedures and techniques.
Supervise, train and mentor associates and interns on audit
process.
Research and analyze financial statement and audit process.

Acquire a working knowledge of the clients business.

Proactively interact with key clients management to gather
information, resolve problems and
Make recommendations for business and process improvements.
***** These definitely makes an audit senior more stressful.

Staff Accountant:

Perform a variety of public accounting duties with general

knowledge of most areas of practice
Interact with clients to help audit team efficiency.
Communicate auditing matters and problems to Senior
Associates, Managers and partners.
Acquire a working knowledge of the clients business.

3. Assume that at some point Tommy told Morrison that he suspected

Carl was not completing his assigned tasks. The only evidence
Tommy had to support his theories was the fact that Carl had come
in significantly under budget on every major task assigned to hi
over a period of several months. If you were Jack Morrison, how
would you have handled this matter?
*** I will check if the issue regarding Carl is really true or not. If it
did happened, I will talk to Carl and remind him that all works in the
firm need focus and need attention because if something happens
unfortunate, the associate, the partners and firm are at stake. Ill
talk to him as a warning for him to do his work better.
4. Again, assume that you are Tommy. Carl is badgering you
something to do midway through the Altamesa job. You suspect
that he is not completing all his assigned procedures, but at the
time you are wrestling with an important and contentious
accounting issue. What would you do at this point? What could you
do to confirm your suspicions that Carl is not completing his
assignments?
***** Of course, first, I will focus in the important matters regarding
audit procedure where my full attention requires. And later on, I will
ask Carl to have a report regarding to his assignment and verify it
on my own understanding to confirm if he did his thing or not.

5. Assume that you are Tommy OConnell and have learned that Carl
Wilmeth will be working for you on the Altamesa audit engagement.
Would you handle this situation in any differently than Tommy did?
Explain.
**** I will reject Carl as my assistant. Because as auditor whether
its senior or staff, must have formal education training and
proficiency to perform audit. Based on what Ive heard about the
performance of Carl, I will open up to Morrison and inform him about
what Ive heard regarding Carl and ask that I would like another
staff accountant since this is my first big project.

III.

CONCLUSION/RECOMMENDATION

One could easily argue that audit seniors occupy the most
critical role on an audit engagement. In most audit engagements, audit
seniors personally oversee the fieldwork. In this role, seniors supervise,
monitor, and review the work of staff accountants, who typically collect most
of the audit evidence on an engagement. In addition, seniors are usually
required to do whats best for the entire firm including the associates.
I recommend that there will be a weekly or monthly meeting of senior
accountants for evaluation for the performance of the associates, the
progress regarding audit, the issues need to be tackled and others so that
everything will be given proper action and avoid conflicts in the future.