Case 1.

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Questions:
1. What factors likely contributed to the oversights made by the Ernst & young auditors during the
2004 AA Capital engagement? Identify measures that audit firms can implement to minimize the
likelihood of such oversights on the audit engagements?

a. There are certainly many factors and many possibilities. One thing to note in the case is that it
is mentioned that McNeely was replaced in 2005 because she was on maternity leave. It is very
possible that she was preparing for pregnancy during the 2004 audit. She made some notes about
these suspicious transactions but she should have managed to get more information and follow
up more aggressively. The fraud should have been discovered during the audit in 2014 if she
stubbornly request for supportive evidence (the documents that proves the tax transactions) from
Stevens and report to Oprins about the lack of evidence.
b. audit firms can establish a rule that , if an auditor found a transaction similar to this one, this
auditor is obliged to report it to the engagement partner and record it in the notes to alert other
auditors during subsequent audits. The audit firms should also use this case to educate future
auditors so that they can avoid the same mistake.
2. Was it appropriate for Ernst & Young to decide not to rely on AA Capitals internal controls
during the 2004 audits? Under what circumstances can auditors choose not to rely on a clients
internal controls?

a. Yes. It was appropriate.

b. Relying on a clients internal controls means that the auditor believes in the reliability and
effectiveness of the companys internal controls. Auditors can choose not to rely on a clients
internal controls when he or she, after testing these controls, determined that there are control
deficiencies or material weaknesses that may lead to material misstatements in the clients
financial statements.
3. What audit procedures do professional auditing standards require that auditors apply to relatedparty transactions? Would any of these procedures have resulted in Ernst & Young discovering the
true nature of the cash transfers made to John Orecchio?

a. The Auditing Standard No. 18 established requirements for the evaluation of a companys
relationships and transactions between the company and related parties. According to AS 18,
there are many steps to follow for the discovery, review and disclosure of related party
transactions. It is required in AS 18 that auditors disclose the related party transactions in the
financial statements.

b. Yes. The original 1.92 million was found to be material and it should have been included in the
notes to be submitted to Oprins, and thus Oprins could be warned and ask more about the
documents supporting this transaction. The inclusion of related party transactions in the notes
also helps the discovery of the embezzlement during subsequent period audits.
4. What objectives do auditors hope to accomplish in performing subsequent period audit tests?
The objective of performing subsequent period audit tests is to determine if events or
transactions occurring after balance-sheet date, but before the financial statements that can
materially affect the financial statements and will require adjustments and/or disclosure in the
statements.
5. Do you agree with the assertion of John Ellingsen that an audit engagement partner is not
responsible for all decisions made in the course of an engagement? Defend your answer. What
quality control implications does that assertion, if true, have for audit firms?

a. No. I dont agree with this assertion because an audit engagement partner should be
responsible for determine the top at the top and oversight all decisions. The partner should be
partially responsible for the decisions made in the course of an engagement.
b. The assertion that an audit engagement partner is not responsible for all decisions made in the
course of an engagement will possibly reduce the quality of future audits because engagement
partners will be less incentivized to take great care of the audit quality due to the lack of
accountability.