Assignment: US Surgical Case
Case Study: The US Surgical Case: 1. Identify audit procedures that, if employed by Ernst & Whinney during the 1981USSC audit, might have detected the overstatement of the leased and loaned assets account that resulted from the improper accounting for assets retirements. There are several audit procedures that, if employed by Ernst & Whinney during the 1981 USSC audit, might have detected the overstatement of the leased and loaned assets account that resulted from the improper accounting for assets retirements.First of all, Ernst & Whinney overlooked an important risk factor of the company’s strong incentive to reach targeted sales and profit goals. In addition, they failed to properly apply analytical procedures during the planning phase.
They also overlooked several material changes in USSC account balances from the end of 1980 to the end of 1981. USSC leased, rather than sold, many of its surgical tools. The company’s accounting staff recorded the cost of these assets in a subsidiary fixed asset ledger, lease and loaned assets.USSC periodically retired such assets and removed their accounts from the sub-ledger. However, SEC investigators discovered that in many cases the costs associated with these assets were not removed from the sub-ledger but instead debited to the accounts of other assets still in service.
The auditors could have used key financial ratios that are used in analytical procedures to detect the overstatement. 2. In 1981, USSC extended the useful lives of several of its fixed assets and adopted salvage values for many of these same assets for the first time.Are these changes permissible under generally accepted accounting principles? Assuming these changes had a material effect on USSC’s financial condition and results of operations, how should the changes have been disclosed in the company’s financial statements? How should these changes have affected Ernst & Whinney’s 1981 audit opinion? (Assume that the current audit reporting standards were in effect at the time. ) There are some situations where this can be within the guidelines of GAAP.
According to APBO Number 20, which was applicable during the 1981 audit period, changes in accounting estimates for asset salvage values and useful life are permissible when updated information is made available that reflects more accurate data and estimates. Currently FASB Statement Number 154 states, “This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate affected by a change in accounting principle.If we assume that these changes are material to the financial statements, then at a minimum, a separate footnote to the financial statements should outline this change. Information such as what depreciation would have been before the change in estimate should be presented along with the current methodology. Also the impact on net income or loss should be disclosed.
The changes without the disclosures should have changed Ernst & Whinney’s 1981 audit opinion away from an unqualified opinion. 3. Prepare common-sized financial statements for USSC for the period 1979-1981.Also, compute key liquidity, solvency, activity, and profitability ratios for 1980 and 1981. Given these data, identify what you believe were the high-risk financial statement items for the 1981 USSC audit. | | | | | | | | | | | | | | | 1981| | 1980| | 1979| Current Assets:| | | | | | | | Cash| | | 0.
2%| | 1. 0%| | 0. 8%| | Receivables (Net)| | 17. 7%| | 25. 6%| | 32. 0%| | Inventories:| | | | | | | | | Finished Goods| | 14.
1%| | 8. 3%| | 8. 1%| | | Work In Process| | 2. 5%| | 2. 2%| | 1.
6%| | | Raw Materials| | 10. 1%| | 15. 8%| | 10. 4%| | | | | 26. 7%| | 26.
3%| | 20. 1%| Other Current Assets| | 3. 8%| | 1. 3%| | 2. 6%| | | Total Current Assets| 48. 4%| | 54.
3%| | 55. 6%| | | | | | | | | | | Property, Plant, And Equipment:| | | | | | | Land| | | 1. 2%| | 2. 0%| | 1. 5%| | Buildings| | 15. 6%| | 15.
5%| | 18. 5%| | Molds and Dies| | 15. 5%| | 13. 4%| | 12. 4%| | Machinery and Equipment| 19.
4%| | 20. 0%| | 17. 5%| | | | | | 51. 7%| | 50. 9%| | 49.
9%| | Allowance For Depreciation| -7. 2%| | -8. 4%| | -9. 0%| | | | | | 44. 5%| | 42. 5%| | 40.
9%| Other Assets| | 7. 1%| | 3. %| | 3. 5%| | | Total Assets| | 100. 0%| | 100. 0%| | 100.
0%| | | | | | | | | | | Current Liabilities:| | | | | | | | Accounts Payable| | 5. 9%| | 5. 8%| | 8. 9%| | Notes Payable| | 0. 0%| | 0. 0%| | 2.
3%| | Income Taxes Payable| 0. 0%| | 1. 4%| | 0. 0%| | Current Portion of Long-| | | | | | | | Term Debt| | 0. 3%| | 0.
6%| | 0. 6%| | Accrued Expenses| | 2. 7%| | 4. 3%| | 7. 3%| | | Total Current Liabilities| 9. 0%| | 12.
1%| | 19. 0%| | | | | | | | | | | Long-Term Debt| | 38. 9%| | 39. 9%| | 47. 5%| Deferred Income Taxes| | 3.
6%| | 2. 5%| | 2. %| | | | | | | | | | | Stockholders’ Equity:| | | | | | | | Common Stock| | 0. 5%| | 0. 8%| | 0. 5%| | Additional Paid-in Capital| 35.
0%| | 29. 3%| | 15. 2%| | Retained Earnings| | 15. 8%| | 17. 5%| | 18. 7%| | Translation Allowance| -0.
5%| | 0. 0%| | 0. 0%| | Deferred Compensation – from| | | | | | | | Issuance of Restricted Stock| -2. 3%| | -2. 2%| | -2.
9%| | Total Stockholders’ Equity| 48. 5%| | 45. 5%| | 31. 5%| | | Total Liabilities and| | | | | | | | Stockholders’ Equity| 100. 0%| | 100.
0%| | 100. 0%| | | | | | 1981| | 1980| | 1979| | | | | | | | | | Net Sales| | | 100. 0%| | 100. 0%| | 100. 0%| Costs and Expenses:| | | | | | | | Cost of Products Sold| 42.
9%| | 37. 5%| | 42. 1%| | Selling, General, and| | | | | | | | Administrative *| | 40. 3%| | 43. 8%| | 39. 3%| | Interest| | | 5.
3%| | 4. 7%| | 5. 6%| | | | | | 88. 5%| | 86. 0%| | 87.
1%| | | | | | 11. 5%| | 14. 0%| | 12. 9%| Income Taxes| | | | | | | | Federal and Foreign| | 0. 7%| | 4. 0%| | 3.
7%| | State and Local| | 0. 3%| | 1. 0%| | 0. 8%| | | | | | 1. 0%| | 4. 9%| | 4.
5%| | | Net Income| | 10. 5%| | 9. %| | 8. 4%| 4. What factors in the auditor-client relationship create a power imbalance in favor of the client? Discuss measures that the profession could take to minimize the negative consequences of this power imbalance. The factor in the auditor-client relationship that creates a power imbalance in favor of the client is that the client executives retain and compensate their company’s auditors.
When technical disputes arise during an audit, client executives may use their leverage on auditors to extract important concessions from them.One measure that the profession could take to minimize the negative consequences of this power imbalance is to set a requirement to rotate audit forms periodically. This would allow the auditors from getting too comfortable with a client. 5. Regarding the costs incurred for USSC by Barden, identify (a) the evidence Hope collected that supported USSC’s claim that the costs involved tooling modifications and (b) the audit evidence that supported the position that the costs were generic production expenses.What do generally accepted auditing standards suggest are the key evaluative criteria that auditors should consider when assessing audit evidence? Given these criteria, do you believe Hope was justified in deciding that the costs in question were for tooling modifications? Why or why not? The auditor’s evidence to support capitalizing generic tooling modifications was inquiry and the touring of a factory.
The auditor toured the plant where these items were made, and based on limited inquiry, decided to accept the capitalization of generic tooling modifications.This decision was made even after invoices were reviewed that suggested that these amounts should not be capitalized. The auditor failed to support the capitalization of these tooling costs with substantive test work. 6. In your opinion, did Hope satisfactorily investigate the possibility that there were additional suspicious tooling charges being paid and recorded by USSC? If not, what additional steps should he have taken to further explore this possibility?If Hope believed there was some likelihood that his client had committed an illegal act, what additional audit procedures, if any, would have been appropriate? (Assume that current auditing standards were in effect at the time. ) Once the auditor discovered that there were invoices from other vendors that allude to the fact that these tooling costs should be expensed for production purposes, the audit program should have been tailored to test enough of these costs to properly determine the proper allocation.
Tests should have been developed to determine the validity of these costs. A confirmation request directed toward the various vendors might have been appropriate. Since the amounts of these costs are material, the auditing firm should have retained an expert in this area of manufacturing and cost allocation. In this situation the auditor may want to consider withdrawing from the engagement. 7.
When a CPA firm has two audit clients that transact business with each other, should the two audit teams be allowed to share information regarding their clients?Why or why not? When a CPA firm has two audit clients that transact business with each other, it raises issues in regard to client confidentiality, information sharing agreements, and how this type of information exchange should be properly managed. I do not believe that the two audit teams should be allowed to share information regarding their clients. Even if it takes a little more work, the audits should be conducted independently of each other and handled as completely separate audit engagements.