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Accounting Chapter 3 And Chapter 4

Accounting Chapter 3 And Chapter 4.


3-24 Patel, CPA, has completed the audit of the financial statements of Bellamy Corporation as of and for the year ended December 31, 2016. Patel also audited and reported on the Bellamy financial statements for the prior year. Patel drafted the following report for 2016.

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We have audited the balance sheet and statements of income and retained earnings of Bellamy Corporation as of December 31, 2016. We conducted our audit in accordance with generally accepted accounting standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of misstatement.

We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly the financial position of Bellamy Corporation as of December 31, 2016, and the results of its operations for the year then ended in conformity with generally accepted auditing standards, applied on a basis consistent with those of the preceding year.

Patel, CPA

Other Information: 

§ Bellamy is a private corporation and is presenting comparative financial statements.

§ During 2016, Bellamy acquired Stockard Inc. and the effects of that transaction are reflected in the current year financial statements. Information about this transaction is disclosed in footnote 12.

§ Patel was unable to perform normal accounts receivable confirmation procedures for accounts that are material, but not pervasive, to the financial statements. Unfortunately, Patel was not able to perform alternative procedures to support the existence of the receivables.

§ Bellamy Corporation is the defendant in litigation where there is a reasonable possibility that Bellamy may be required to pay a substantial amount of cash, which might require the sale of certain fixed assets. Because management does not want to provide any information that the plaintiff might use against Bellamy, the case is not discussed in the financial statements.

§ Bellamy issued debentures on January 31, 2015, in the amount of $10 million. The funds obtained from the issuance were used to finance the expansion of plant facilities. The debenture agreement restricts the payment of future cash dividends to earnings after December 31, 2020. Bellamy has disclosed this in the footnotes to the financial statements.


a. Identify and explain any items included in “Other Information” that need not be part of the auditor’s report.

b. Explain the deficiencies in Patel’s report as drafted.*

*Based on AICPA question paper, American Institute of Certified Public Accountants.

3-26 For the following independent situations, assume that you are the audit partner on the engagement:

1. A number of frozen yogurt stores have opened in the last few years and your client, YogurtLand, has experienced a noticeable decline in customer traffic over the past several months that has caused you to have substantial doubt about YogurtLand’s ability to continue as a going concern.

2. Intelligis Electronics is a manufacturer of advanced electrical components. During the year, changes in the market resulted in a significant decrease in the demand for their products, which are now being sold significantly below cost. Management refuses to write-off the products or to increase the reserve for obsolescence.

3. In the last 3 months of the current year, Oil Refining Company decided to change direction and go significantly into the oil drilling business. Management recognizes that this business is exceptionally risky and could jeopardize the success of its existing refining business, but there are significant potential rewards. During the short period of operation in drilling, the company has had three dry wells and no successes. The facts are adequately disclosed in footnotes.

4. Your client, Harrison Automotive, has changed from straight-line to sum-of-the-years’ digits depreciation. The effect on this year’s income is immaterial, but the effect in future years may be highly material. The change is not disclosed in the footnotes.

5. Marseilles Fragrance, Inc., is based in New York but has operations throughout Europe. Because users of the audited financial statement are international, your audit firm was engaged to conduct the audit in accordance with U.S. auditing standards and International Standards on Auditing (ISAs).

6. Circumstances prevent you from being able to observe the counting of inventory at Brentwood Industries. The inventory amount is material in relation to Brentwood Industries’ financial statements. But, you were able to perform alternative procedures to support the existence and valuation of the inventory at year-end.

7. Approximately 20% of the audit of Lumberton Farms, Inc., was performed by a different CPA firm, selected by you. You have reviewed their audit files and believe they did an excellent job on their portion of the audit. Nevertheless, you are unwilling to take complete responsibility for their work.


For each situation, do the following:

a. Identify which of the conditions requiring a deviation from a standard unmodified opinion audit report is applicable, if any.

b. State the level of materiality as immaterial, material, or highly material. If you cannot decide the level of materiality, state the additional information needed to make a decision.

c. Given your answers in parts a. and b., state the appropriate audit report from the following alternatives (if you have not decided on one level of materiality in part b., state the appropriate report for each alternative materiality level):

1. Unmodified opinion—standard wording

2. Unmodified opinion—explanatory paragraph

3. Unmodified opinion—nonstandard report wording

4. Qualified opinion only—GAAP departure

5. Qualified opinion—scope limitation

6. Disclaimer

7. Adverse*

3-29 The International Auditing and Assurance Standards Board (IAASB) recently revised its standards related to audit reporting. ISA 700 (Revised), Forming an Opinion and Reporting on Financial Statements, requires the auditor’s report to include the following paragraphs under the headings “Basis for Opinion” and “Auditor’s Responsibilities for the Audit of the Financial Statement”.

Basis for Opinion:

We conducted our audit in accordance with International Standards on Auditing (ISAs). 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 International Ethics Standards Board for Accountants’ Code of Ethics for Professional Accountants (IESBA Code) together with the ethical requirements that are relevant to our audit of the financial statements in [the home country] and we have fulfilled our other ethical responsibilities in accordance with these requirements and the IESBA Code. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

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 ISAs will always detect a material misstatement when it exists. Misstatements 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.


Read the preceding paragraphs to answer the following:

a. How does the information in the preceding paragraphs compare to the information in the paragraphs under the “Auditor’s Responsibility” heading in the standard unmodified opinion audit report example for a nonpublic company shown in Figure 3-1? (Figure 3-1 is attached in the uploaded documents).

b. How does the information in the preceding paragraphs compare to the information in the scope paragraph in the standard unmodified opinion audit report example for a public company shown in Figure 3-3 ? (Figure 3-3 is attached in the uploaded documents).

c. Discuss whether you believe these paragraphs in the ISA audit report improve auditor communications to users of the financial statements.


4-21 The following situations involve the provision of nonaudit services. Indicate whether providing the service is a violation of AICPA rules or SEC rules including Sarbanes–Oxley requirements on independence. Explain your answer as necessary.

a. Providing bookkeeping services to a public company. The services were preapproved by the audit committee of the company.

b. Providing internal audit services to a public company audit client with the preapproval of the audit committee.

c. Providing advice to a private company client on accounting for a merger with ­another private company.

d. Providing bookkeeping services to a private company. The source documents were prepared and authorized by the client.

e. Providing internal audit services to a public company that is not an audit client.

f. Implementing a financial information system designed by management for a private company.

g. Recommending a tax shelter to a client that is publicly held. The services were preapproved by the audit committee.

4-22 Each of the following situations involves a possible violation of the AICPA Code of Professional Conduct. For each situation, state the applicable rule of conduct and whether it is a violation.

a. Emrich, CPA, provides tax services, management advisory services, and bookkeeping services and also conducts audits for the same nonpublic client. Because the firm is small, the same person often provides all the services.

b. Steve Custer, CPA, set up a casualty and fire insurance agency to complement his auditing and tax services. He does not use his own name on anything pertaining to the insurance agency and has a highly competent manager, Jack Long, who runs it. Custer often requests Long to review the adequacy of a client’s insurance with management if it seems underinsured. He believes that he provides a valuable service to clients by informing them when they are underinsured.

c. Seven small Seattle CPA firms have become involved in an information project by taking part in an interfirm working paper review program. Under the program, each firm designates two partners to review the audit files, including the tax returns and the financial statements, of another CPA firm taking part in the program. At the end of each review, the auditors who prepared the working papers and the reviewers have a conference to discuss the strengths and weaknesses of the audit. They do not obtain authorization from the audit client before the review takes place.

d. Franz Marteens is a CPA, but not a partner, with three years of professional experience with Roberts and Batchelor, CPAs. He owns 25 shares of stock in an audit client of the firm, but he does not take part in the audit of the client, and the amount of stock is not material in relation to his total wealth.

4-24 Marie Janes encounters the following situations in doing the audit of a large auto dealership. Janes is not a partner.

1. The sales manager tells her that there is a sale (at a substantial discount) on new cars that is limited to long-established customers of the dealership. Because her firm has been doing the audit for several years, the sales manager has decided that Janes should also be eligible for the discount.

2. The auto dealership has an executive lunchroom that is available free to employees above a certain level. The controller informs Janes that she can also eat there any time.

3. Janes is invited to and attends the company’s annual holiday party. When presents are handed out, she is surprised to find her name included. The present has a value of approximately $200.


Use the three-step process in the AICPA conceptual framework to assess whether Janes’ independence has been impaired.

a. Describe how each of the situations might threaten Janes’ independence from the auto dealership.

b. Identify a safeguard that Janes’ firm could impose that would eliminate or mitigate the threat of each situation to Janes’ independence.

c. Assuming no safeguards are in place and Janes accepts the offer or gift in each situation, discuss whether she has violated the rules of conduct.

d. Discuss what Janes should do in each situation.

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Accounting Chapter 3 And Chapter 4


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