Case 2.2 And 2.5 Answers 5q244f

Case 2.5 dollar General Stores, Inc. 1. Identify audit procedures that might have detected the improper ing treatment applied by Dollar General to the transaction with IBM. In accordance with AIA, there is a long history of other types of revenue-recognition manipulations involving related parties that are connected with fraudulent financial reporting such as sales without substance, including funding the buyer, for example, so collection is assured, sales with a commitment from the seller to repurchase that, if known to the auditor or SEC, would preclude revenue recognition, and sales with a guarantee by an entity financed by the seller of what would otherwise be viewed as an uncollectible receivable. These schemes are sometimes referred to as sham transactions: The transaction appears to be a genuine sale, but it isn't. The buyer goes through the motions so the seller can recognize the revenue. Fraud risk factors. Many related-party transactions are linked to fraud. The auditor should view the risk factors as a warning that fraud may exist, as required by SAS no. 82. If the auditor sees any one or a combination of the following risk factors, he or she should react accordingly: -Significant related-party transactions outside the ordinary course of business or with unaudited entities. -Significant unusual or highly complex transactions, especially those close to the end of a reporting period. -Significant bank s or operations in tax havens for which there appears to be no clear business justification. -An organizational structure with a high degree of complexity that is without apparent business purpose. -Difficulty in determining who controls the entity. ing sense. The assumption that financial statements reflect arm's-length bargaining between independent parties is fundamental to financial reporting. However, when transactions differ materially from their economic substance, immediate profit recognition generally should be deferred. Profit should not be recognized until there is an exchange transaction with an unrelated party. For example, when an entity has created the other party and is effectively both buyer and seller, revenue recognition generally is inappropriate even if the relationship is disclosed. Auditing alert. The auditor should be on the lookout for the existence of undisclosed related parties and the possibility of fraud. SAS no. 45, Omnibus Statement on Auditing Standards— 1983, includes several procedures for identifying undisclosed related-party relationships. The auditor should be watching for them when doing a Review of conflict-of-interest statements obtained by the company from its management. -Review of the extent and nature of business transacted with major customers, suppliers, borrowers and lenders to look for previously undisclosed relationships. -Review of ing records for large, unusual or nonrecurring transactions or balances, paying particular attention to transactions recorded at or near the end of the reporting period. -Review of confirmations of loan receivables and payables for indications of guarantees. When a review reveals a significant transaction involving a guaranty or similar relief of a transaction principal from risk of loss, the auditor should seek information on the nature and extent of the guaranty and the full identity of the guarantor. The auditor can also do the following: -Ask tax and consulting personnel who provide services to the client about their knowledge of management's involvement in material transactions or with transaction principals.

-If the company is going public, review information obtained by its securities counsel about management relationships for registration statement disclosure. -Use the Internet and other sources of information (such as newspapers, phone books and industry or trade publications) to search for information about key of management and the company. For example, an Internet name search will list for 47 states the corporation and limited partnership records in which that name appears. -Review material cash disbursements, advances and investments to see whether the client provided funds to a related entity. -Discuss with intermediaries (such as lawyers, predecessor auditors or others providing professional services) what they know about the principal parties to material transactions. If the auditor's procedures uncover the existence of related-party transactions that were concealed deliberately, the auditor must determine their effects on the audit, especially the implications for management integrity. 2. Identify the ing concepts or principles violated by Dollar General in this case. Defend each of your choices. SEC Rule 10b-5: A regulation formally known as the Employment of Manipulative and Deceptive Practices that was created under the Securities Exchange Act of 1934. This rule deems it to be illegal for anybody to directly or indirectly use any measure to defraud, make false statements, omit relevant information or otherwise conduct operations of business that would deceive another person; in relation to conducting transactions involving stock and other securities. Examples of offenses that would violate rule 10b-5 would be: executives making false statements in order to drive up share prices or a company hiding huge losses or low revenues with creative ing practices. SEC Rule 10b-5 was violated by Dollar General with the help of IBM. Dollar General wanted to hide the loss of the worthless cash s which would make their 2000 net income lower by an estimated six to seven percent by using the two-way transaction. Case 2.2 Golden Bear Golf, Inc. 1. SAS No. 106, “Audit Evidence,” identifies the “management assertions” that commonly underlie a set of financial statements. Which of these assertions were relevant to Paragon’s construction projects? For each of the assertions that you listed, describe an audit procedure that Arthur Anderson could have employed to corroborate that assertion. The assertions that were relevant to Paragon’s construction projects include completeness, valuation and allocation and existence and occurrence Completeness: The SEC said that Sullivan and his subordinates should have tested Paragon’s large amounts of unbilled revenues. A significant amount of unbilled revenue that is reported as complete should be tested to determine the reason why no billing has been posted for the work that was done. Moreover, it should be determined the reason why income is being recognized for jobs that have not been identified as works in progress to determine the exact completion date of the project. By testing this assertion it would have been discovered that $4 million of work was fictitious.

Valuation and allocation: Arthur Anderson should have sent out s receivable confirmations for the unbilled transactions included in their revenues and also to those with the people they had contracts that were inflated in their s to reconcile differences between the books and the contracts. This would have not only shown that many of the revenues they had booked were not only inaccurate, but that many of them had been fabricated completely. This could have also shown that Paragon was billing their clients on a cost-to-cost basis that would have shown that the valuation and allocation of balances were misstated. Visits to job sites would have also helped to identify the progress toward completion which could have shown the auditors that they valuation and allocation was misstated for their construction projects. Existence and occurrence: This method should have been used to test the revenue and gross profit on its construction projects. By testing to see if the assertion is appropriate to make sure that all revenue and gross profit exist would have brought the attention to the $4 million of uninvoiced construction costs that materialized. This assertion test also would have revealed that the earned value method in practice was allowing Paragon to book much larger amounts of revenue and gross profit on its construction projects than it would have under the cost-to-cost method. 3. Sullivan identified the 1997 Golden Bear audit as a “high-risk” engagement. How do an audit engagement team’s responsibilities differ, if at all, on a high-risk engagement compared with a “normal” engagement? Explain. According to SAS 99, in obtaining information needed to identify risks of material misstatement due to fraud, there should also be a partner/manager discussion with the clients’ management, the audit committee and others (i.e., internal audit team, legal counsel, and other personnel not directly involved in financial reporting). The auditor should make inquiries of management and others within the client's entity to obtain their views about the risks of fraud (and whether they are aware of any fraudulent activities that have occurred in the firm) and how they are addressed .Auditors can provide management with their fraud risk assessment prior to their meeting, as well as sharing additional concerns with them at the meetings. It is also important to have people with the appropriate level of experience leading these discussions. Additionally, if engagement risk is greater than normal, the audit engagement team should consider involving a forensic auditor in the fraud discussion meeting. Forensic auditors provide an in-depth perspective of how and why a fraud may be perpetrated, and will raise the level of professional skepticism within the engagement team. The auditor's response to the assessment of the risks of material misstatement of the financial statements due to fraud is influenced by the nature and significance of the risks identified as being present, and the entity's programs and controls that address these identified risks. The auditor should respond to risks of material misstatement due to fraud in one of three ways: a response that has an overall effect on how the audit is conducted, a specific response to identified risks involving the nature, timing, and extent of the auditing procedures to be performed, and a response involving the performance of certain procedures to further address the risk of material misstatement due to fraud involving management override of controls, given the unpredictable ways in which such over-ride can occur. The auditor should respond to risks that have an overall effect on how the audit is performed with increased professional skepticism, to ensure the sufficiency and reliability of the audit evidence and additional corroboration. The personnel or specialists assigned to the audit engagement should have a level of skill commensurate with the assessed risk. This may require

the assignment of additional or more experienced personnel to the engagement. The auditor should also review the overall application of ing principles and any resulting biases detected. In this respect, the auditor must consider whether the ing principles and policies adopted by management, individually or collectively, create a material misstatement of the financial statements. Finally, the auditor should add an element of unpredictability in the selection of audit procedures from year to year such as sampling methodology, timing, locations, etc. In response to specifically identified risks, the auditor may modify the nature, timing, and extent of both substantive tests and tests of controls. The nature of auditing procedures may be changed to obtain evidence that is more reliable. The timing of a substantive balance test may be moved from an interim date to period-end, to be more effective. The extent of the procedures applied may be increased by using larger sample sizes. Examples of such modifications include: performing procedures at locations on a surprise or unannounced basis; requesting inventory counts closer to period-end to minimize the risk of irregularities; performing substantive analytical procedures using disaggregated data, etc.