Republic of the Philippines

POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

COLLEGE OF ACCOUNTANCY AND FINANCE
Sta. Mesa, Manila

ASSURANCE PRINCIPLES, PROFESSIONAL ETHICS AND GOOD GOVERNANCE

ACCO 3116

CASES IN AUDITING

Presented to:

Professor Maria Luisa U. Oliveros

Presented by:

BSA 3-1

Ang, Wilson

Bondoc, Liezel Lyn C.

Esquejo, Venus

Guevara, Maria Helen

Padilla, Nathalie Valerie M.

Peñaflor, Ferdinand Froilan Vincent Percival

Vicente, Ruel M.

January 11, 2019

 CASE 1:
ANALYSIS OF POTENTIAL
AUDIT CLIENT
WRITTEN QUESTIONS

1. Following the above conference with Rogers, Abernethy asks Andrews to produce a

memo listing the potential problems that the firm might encounter in this audit.

Prepare this memo for the lakeside engagement. Include all accounts and transactions

that seem to require special attention. Evaluate the possible severity of each of these

concerns.

Area that Should be Reviewed Purpose of Review

To determine the type and materiality of the

Proposed Adjusting Entries
proposed adjustments

Ensure that the opening balances were audited

Opening Balances in Accounts
and that enough evidence was collected

Evaluate if internal controls have any

Look Through Work Papers weaknesses or if there are any areas that do not

Regarding Internal Controls have controls in place, as well as strong controls

that are in place

Understand accounting principles Understand how Lakeside has consistently

that Lakeside previously used recorded their accounts

Understand what previous auditors found and

be wary of that information while moving

Audit Results
forward with the client.

For example, the “impairment of value”

 from the case

Decide if the predecessor’s planning steps of the

audit were efficient or not, and then compare

their planning steps to those of Abernethy and

Documentation of Audit Planning
Chapman. This could save time in the future

while going through the audit and make the

audit more thorough

Understand what King Company’s thoughts and

concerns of Lakeside’s contingency plan were

Contingencies
and use them for further insight when

Abernethy and Chapman look into the

contingency plan

Determine if Lakeside Company has any unique

Significant and Unusual Transactions
transactions that could

2. Andrews was also assigned to visit the headquarters/warehouse of lakeside to tour the

facility. What should Andrews observe, and what factors should he be especially aware

of during this visit?

3. Prepare the auditor’s report that king and company rendered at the end of the 1990

engagement. How does this qualified opinion differ from a standard auditor’s report?
 INDEPENDENT AUDITOR'S REPORT

To the Board of Directors:

Report on the Audit of the Financial Statements

Opinion

We have audited the accompanying balance sheet of the Lakeside Company as of

December 31, 2011, and the related statements of income, retained earnings, and cash

flows for the year then ended. These financial statements are the responsibility of the

Company's management. Our responsibility is to express an opinion on these financial

statements based on our audit.

Basis for Opinion

We conducted our audit in accordance with auditing standards generally accepted in

the United States of America. Those standards require that we plan and perform the

audit to obtain reasonable assurance about whether the financial statements are free of

material misstatement. An audit includes examining, on a test basis, evidence

supporting the amounts and disclosures in the financial statements. An audit also

includes assessing the accounting principles used and significant estimates made by

management, as well as evaluating the overall financial statement presentation. We

believe that our audit provides a reasonable basis for our opinion.

During 2010, the Lakeside Company made a large investment in a retail store located in

the eastern sector of Richmond, Virginia. This store has failed to reach a break-even

sales point to date, and total recovery of the Company's investment is highly uncertain.
In our opinion, the chances are reasonably possible that the asset's value has been

permanently impaired and should be reduced to the net realizable value in conformity

with generally accepted accounting principles. Management of the company has refused

to recognize this impairment loss.

In our opinion, except for the effects of not recording or disclosing the impairment of

value of the asset, as discussed in the preceding paragraph, the aforementioned

financial statements present fairly, in all material respects, the financial position of the

Lakeside Company at December 31, 2011, and the results of its operations and its cash

flows for the year then ended in conformity with accounting principles generally

accepted in the United States of America.

King and Company (signed), Certified Public Accountants

Date: (last day of audit fieldwork)

 CASE 2:
NEW CLIENTS AND AN
AUDITOR’S LEGAL LIABILITY
WRITTEN QUESTIONS

1. Exhibits 2-1 and 2-2 are attached. From the information that has been presented in the

first two cases, complete these forms.

Exhibit 2-1

Abernethy and Chapman

Analysis of Potential Legal Liability

Potential Client: Lakeside Company

Type of Engagement: External Audit

Form Completed by: Date:

1) Is the potential client privately-held or publicly held?

Privately held.

2) Evaluate the possible liability to the client that Abernethy and Chapman might incur if

the engagement is accepted.

If Abernethy and Chapman perform the engagement as an average, no problem exists. If

not, the client may sue for return of its audit fee as well as any other resulting losses
Moreover, the client company has a weak internal control therefore; fraud or

embezzlement can be increased. Proving this company innocent is difficult.

3) List the third parties that presently have a financial association with the potential client

and could be expected to see the financial association with the potential client and

could be expected to see the financial statements.

- Cypress Products

- Two Richmond banks financing the inventory

- National Insurance Company of Virginia

4) Discuss the possibility that other third parties will be brought into a position where

they would be expected to see the financial statements of the potential client.

These parties are also called foreseeable beneficiaries. The financial statements could be

presented to a potential stockholders or lender.

5) Evaluate the possible liability to third parties, both present and potential, that

Abernethy and Chapman might incur if the engagement is accepted.

If the engagement is accepted, the CPA firm should have no liability to third parties because

it is privately held the business this audit firm does not fall under federal security laws.
 Exhibit 2-1

Abernethy and Chapman

Information from Predecessor Auditor

Potential Client: Lakeside Company

Form Completed By: Abernethy and Chapman

Predecessor Auditor: king and Company

Date of Interview: June 15, 1991

1. Discuss the predecessor auditor's evaluation of the integrity of the management of the

potential client.

Rogers and all of the members of his organization appear to be people of integrity.

2. Did the predecessor auditor reveal any disagreement with management as to

accounting principles, auditing procedures, or other similarity significant matters? If so,

fully describe these disagreements.

Rogers didn’t want his shareholders or the banks to know about the impairment of value

problem. He didn’t want to write down the reported value of the 6th store. According to

him, no real impairment existed even if it did the potential loss in not material.
3. What was the predecessor auditor's understanding as to the reasons for the change in

auditors?

King indicated that their qualified opinion in the audit report was the reason that Lakeside

Company wanted to seek a new independent auditor. Also, he mentioned that Rogers

always complained about the audit fees

4. Did the predecessor auditor give any indication of other significant audit problems

associated with the potential client?

King mentioned the Lakeside’s internal control system is antiquated. An ineffective internal

control system will result in less reliable information and even create opportunity for fraud

with the failure of detection by an auditor. In addition, King talked that Rogers do not

understand an auditor’s work and is unwilling to spend money. Without sufficient fees,

A&C might face problem in their future auditing work especially in Lakesides’ expansion

5. Did the predecessor auditor indicate any problem in allowing Abernethy and Chapman

to review prior years working for the potential client? If yes explain.

King did not indicate any problem in allowing A&C reviewing prior years’ Audit

documentation if A&C accept the engagement.

6. Was the predecessor auditor's response limited in any way?

There is no limitation according to King’s response. King explained the reason why they

gave a qualified opinion on the audit report.

2. If the firm of Abernethy and Chapman does seek and receive this audit engagement, a

review will be made of the working papers produced by the predecessor auditor.

Prepare a list of the specific contents that should be examined. Indicate each area that

should be reviewed and the purpose of studying these particular working papers.

The Auditor has to assess and review the audit document prepared by the predecessor

auditor through series of steps. The goal is to examine the types of information that would

be available to an auditor in an ongoing engagement.

Review of audit documents prepared by predecessor auditor. Areas to be reviewed and the

purpose of review:

Adjusting Entries

* To determine the accounts that would be affected and the materiality of adjustments.

Internal control

* To see the areas where control is weak or strong.

Beginning balances of Accounts

* To verify the precision of beginning balances through audit evidence since successor

auditor audits ending balances.

Problems

* To assess if the problem is still existing. (Periodical write-off of Accounts Receivable)

Contingencies

* To know if there is a need for the auditor to disclose or adjust contingencies in the current

period.

Accounting principles applied

* To determine whether principles have been consistently observed in the fiscal year in

relation to the current year.

3. Assume that Abernethy and Chapman audit’s Lakeside’s 1991 financial statements and

gathers sufficient, competent evidence to render an unqualified opinion without any

mention of the uncertainty. Assume further that lakeside opts to issue comparative

statements showing figures for 1990 and 1991. Write a single audit report that will

inform the render of both opinions, as well as the examination made by the previous

auditors.
 Independent Auditor's Report

To the shareholder of Lakeside Company

Report on the Audit of the Financial Statements

Opinion

We have audited the financial statements of Lakeside Company which comprise the

statements of financial position as at December 31 1990 and 1991, and the statements of

comprehensive income, statements of changes equity and statement of cash flows for the

years then ended, and notes to financial statement, including a summary of significant

accounting policies.

In our opinion, the accompanying financial statements present fairly, in all material

respects, the financial position of the company as at December 31 1990 and 1991, and its

financial performance and its cash flows for the year ended in accordance with Philippines

Financial Reporting Standards (PFRSs).

Basis for Opinion

We conducted our audit in accordance with Philippine standards on auditing (PSAs). Our

responsibilities under those standards are further described in the Auditor's

Responsibilities for the audit of the financial statements section of our report. We are

independent of the company in accordance with the code of ethics for Professional

accountants in the Philippines (Code of Ethics) together with the ethical requirements that

are relevant to our audit of the financial statements in the Philippines, and we have fulfilled
our ethical responsibilities in accordance with these requirements and the code of ethics.

We believe that the audit evidence we have obtained is sufficient and appropriate to

provide a basis for our opinion.

Other Matter

The financial statements of Lakeside Company for the year ended December 31 1990 were

audited by King and Company (another auditor) who expressed a going concern

uncertainty opinion on those statements.

Responsibilities of Management and Those Charged with Governance for the

financial statements

Management is responsible for the preparation and fair presentation of the financial

statements in accordance with PFRSs, and for such internal control as management

determines is necessary to enable the preparation of financial statements that are free from

material misstatement, whether due to fraud or error.

In preparing the financial statements, management is responsible for assessing the

company’s ability you continue as going concern, disclosing, as applicable, matters related

to going concern and using the going concern basis of accounting unless management

either intends to liquidate the company or to cease operations or has no realistic

alternative but to do so.

Those charged with Governance are responsible for overseeing the company's financial

reporting process.
Auditor's Responsibilities for the Audit of the Financial Statements

Our objectives are to obtain reasonable assurance about whether the financial statements

as a whole are free from material misstatement, whether due to fraud or error, and to issue

an auditor's report that includes our opinion. Reasonable assurance is a high level of

assurance but is not a guarantee that an audit conducted in accordance with PSAs will

detect a material misstatement when it exists. Misstatement can arise from fraud or error

and are considered material if, individually or in the aggregate, they could reasonably be

expected to influence the economic decisions of users taken on the basis of these financial

statements.

As part of an audit in accordance with PSAs, we exercise professional judgment and

maintain professional skepticism throughout the audit. We also:

* Identify and assess the risks of material misstatement of the financial statements,

whether due to fraud or error, design and perform audit procedures responsive to those

risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our

opinion. The risk of not detecting s material misstatement resulting from fraud may involve

collusion, forgery, intentional omissions, misrepresentation or the override of internal

control.

* Obtain an understanding of internal control relevant to the audit in order to design audit

procedures that are appropriate in the circumstances, but not for the purpose of expressing

an opinion on the effectiveness of the Company's internal control.

* Evaluate the appropriateness of accounting policies used and reasonableness of

accounting estimates and related disclosures made by the management.

* Conclude on the appropriateness of management's use of going concern basis of

accounting and based on the audit evidence obtained, whether a material uncertainty exists

related to events or conditions that may cast significant doubt on the company's ability to

continue as going concern. If we conclude that a material uncertainty exists, we are

required to draw attention in our auditor's report to the related disclosures in the financial

statements or, if such disclosures are inadequate, to modify our opinion. Our conclusion are

based in the audit evidence obtained up to the date our auditor's report. However, future

events or conditions may cause the company to cease to continue as going concern.

* Evaluate the overall presentation, structure and content of the financial statements,

including the disclosures, and whether the financial statements represent the underlying

transactions and events in a manner that achieves fair presentation.

We communicate with those charged with governance regarding, among other matters, the

planned scope and timing of the audit and significant audit findings, including any

significant deficiencies in internal control that we identify during our audit.

Report on other legal and regulatory requirements

Our audits were conducted for the purpose of forming an opinion on the basic financial

statements taken as a whole. The supplementary information for the year ended December

31 1991 required by the Bureau of internal revenue is presented for the purpose of

additional analysis and is not required part of the basic financial statements prepared in
accordance with PFRS. Such supplementary information has been subjected to the auditing

procedures applied in the audit of the basic financial statements and in our opinion is fairly

stated in all material respects in relation to the basic financial statements taken as a whole.

(Auditor name, signature above)

Abernethy and Chapman

(Office place)

January 11 1992
 CASE 3:
INTERNAL CONTROL
STRUCTURE
WRITTEN QUESTIONS

1. To gain an understanding of the client’s present accounting systems, the firm of

Abernethy and Chapman has a policy that all systems must be recorded in a memo and

a flowcharting format. By using both, staff members are able to achieve a better and a

quicker understanding of the design of each system.

Bases on Exhibit 3-4, Prepare a flowchart to provide a graphic display of this system.

Use the flowchart symbols that appear in Exhibit 3-3

Next analyze Exhibit 3-5, a flowchart representation of the cash receipts procedures,

and prepare a written memorandum to accompany and explain this particular system.
Treasurer’s Office: Receives checks from customers along with the copy of the invoice slips.

Those checks are immediately marked as "for deposit only" without other's examining. The

checks are listed on the bank deposit slip. After that, the checks and the bank deposits are

taken by the bank which then issued two Validated Deposit Slips of which the first is for the

Assistant to President. The Cash Remittance List 1,2 and 3 indicating customer name,

amount paid, and invoice number, along with the invoice slip are handed to the Sales

Division. The Treasurer's Office then matched the second Validated Deposit Slip with the

4th Remittance Slip and both remained in the Treasurer's Office in a permanent file by

date.

Assistant to President: The Validated Deposit Slip 1 from the Treasurer's Office is filed in a

temporary file by date which is then matched with the Remittance List 1 from Sales

Division. The Cash Remittance List total is compared to the Bank Deposit Slip total.

Individual items are randomly reconciled, accounts receivable subsidiary ledger is also

updated. After the process, the documents are temporarily filed and are used in preparing

for the monthly bank reconciliation with the Bank Statement from Bank. The Assistant to

President spots check Cash Remittance List totals and dates against Bank Statement. After

the process, the Remittance List, Bank Statement, Deposit Slip 1 and the Bank

Reconciliation are kept in a permanent file by date.

Sales Division: The first three Remittance Lists along with the Invoice Slip from the

Treasurer's Office are matched with the Bill of Lading and Sales Invoice 2. The appropriate

discounts calculated are recorded on each copy of Cash Remittance List. The first

Remittance List is transferred to the Assistant to President while the Bill of Lading 4, Sales
Invoice 2, and Invoice Slip are kept in a permanent file by invoice number. The second

Remittance List is delivered to the Controller's Office while the third Remittance List is kept

in a permanent file by date.

Controller's Office: The second Remittance Slip from Sales Division is being re-footed along

cash receipts and sales discounts which after then are recorded in cash receipts journal.

The Remittance Slip 2 is placed in a permanent file, by date.

2. At the firm of Abernethy and Chapman, after the memo and flowchart have been

prepared, a preliminary analysis is made of the internal control policies and procedures

found in the system. The auditor is searching for weaknesses within the structure of the

system as well as nay particularly strong features that would reduce control risk. To

assist the auditor in evaluating a system, Abernethy and Chapman utilizes the form

presented in Exhibit 3-6. Complete this document based on the flowchart in Exhibit 3-5

representing the Cash Receipts section of the Revenue and Cash Receipts cycle. Be

especially careful to note any internal control weaknesses or strengths that may be

indicated.

Answer each of the following questions. For each "No" answer, comment on whether an

internal control weakness is indicated.

(1) Is each document within this system pre-numbered? Yes. Each document within the

system is numbered in order for better accessibility of the report prepared.

(2) Is the authority for completing each document clearly delineated? Yes. All processes

made by the team are based on standards and so authority and complete.
(3) Are all documents subsequently reviewed by an independent party within the

company? Yes. A number of the documents are reviewed prior to the beginning of this

system such as the sales invoice and bill of lading.

(4) Are appropriate procedures clearly spelled out for completing and reviewing each

document? Yes, in order for better performance and analysis of the document. We used

procedures to help us complete the review of the documents.

(5) Is the record-keeping function independent of the custody function at all points

throughout the system? Yes. Records such as receipts and invoices are provided with lots

of copies for better keeping of documents throughout the system.

(6) Are all mathematical computations independently verified? No. All computations are

independently verified except for the cash discount. The flowchart is unclear as to the

procedures to be applied when the sales division calculation does not agree with the

customer payment.

(7) Does record-keeping begin at the origin of the transaction? Yes, as stated in revenue

and cash receipts cycle presented by Lakeside Company, we can say that record-keeping

began in the origin of the transaction.

(8) Are all transactions authorized? Yes. All transactions pass through different

departments and then assessed by the higher management for authorization.

Overall Lakeside has a high risk of potential misstatements and materiality gives their set

of internal controls. Although they have an outside computer center to keep track
inventory, sales and purchases. There is still high risk when it comes to accuracy of the

information being submitted. Ms. Luck is the controller’s Office, is responsible for manually

recording transactions from the third copy of bill of lading. Whether due to human error or

other factors these records could be misrepresented and would lead to misstatement as Ms.

Lucks work is not double checked. If an error were to occur this could lead to incorrect

inventory verifications and massive amounts of fluctuations as information is submitted on

weekly basis.

3. Rogers has stated that he wants the auditing firm to help improve Lakeside’s accounting

systems. Exhibit 3-4 identifies the revenue recognition procedures currently used in

connection with distributorship sales. List improvements that could be made in this

system:

(1) A new department should be added to the revenue recognition cycle to help the process

move at a smoother rate. This department monitors customer accounts and keep a closer

eye on the documents that are.

(2) After writing his final decision to approve or reject the order on the invoice, Mr. Rogers

should make a copy of the document to keep before sending it to the sales division. It is

important to keep evidence of a decision on file in case discrepancy occurs.