The new rash of highly publicized a...

The new rash of highly publicized audit failures in Canada and the US has emphasized the importance of auditors' professional skepticism. Three novel cases in BC also underscore in what manner important it is for auditors to weigh sufficient appropriate audit evidence against management representations.

These fictionalized accounts are based loosely in succession actual cases before the Professional bearing Enquiry Committee (PCEC). Names and circumstances have been changed to defend anonymity.

Case #1

The issue for our first member troubleed the valuation of a long-term investment. single in kind of his public company clients had acquired an operating subsidiary. This subsidiary held shares representing just les than 20% of another public company-"Investee"-which it had acquired in the reconciliation of a debt. After several years of reasonably profitable operations, Investee had supported two years of significant losse and had accumulated a large deficit. according to the time our member became involved, Investee had ceased operations and was barely managing to maintain its exchange listing.

The clients management argued that Investee's pictures were good-assuming it could achieve a merger with another company in the same industry. Management also pointed on the outside that the CICA Handbook considers three or four years as indicative of a permanent decline (Section 305024) while Investee's value had been in decline for and nothing else two years.

Case #2

Our inferior member had a public company client-"ClientCo"-that had licensed its technology to a private start-up company overseas-"OverseasCo"-and had accrued related receipts OverseasCo also provided ClicntCo with vital raw materials.

Agreements between the sum of two units companies provided settlement terms, including the possibility of OverseasCo paying in kind with raw materials. However, our member was unable to verify the raw materials held for ClientCo's account as payment in kind as they were stored overseas. on year-end, supplies on hand be superior toed ClientCo's highest projected annual usage, and by the agency of the audit report date, OverseasCo was significantly in arrears in its payments. yet it confirmed its debt to ClientCo, Overseas Co failed to yield its financial statements to our member-despite repeated ask fors Therefore our member had no guarantees of OverseasCos payments, and could not determine to what extent ClientCo could take possession of the inventory payment in kind.

Nevertheless, management in-sisted that accrual of the unpaid reward was appropriate because OverseasCo was projecting significant extension and increased cash flow from the use of the ClientCo technology.

Case #3

Our third member audited a publicly traded financial services company-"FinCo." FinCo's operations consisted primarily of financing leases for a wide range of clients. the same group of companies-"borrower"-accounted for almost the same quarter of this line of business. In the period posterior to the year-end in question, Borrower's payments had slowed, virtually ceasing according to the audit report date. Borrower confirmed its liability without exceptions, and FinCo management persuaded our member that Borrower was purely experiencing a cyclical slow period and would definitely pay its accounts.

The member did not investigate whether Borrower's business was make liable to significant seasonal or business period variations and did not ask for FinCo's flnancials, equable though FinCo's agreements with its clients required provision of common financial statements.

What happened

In all three cases, our members accepted managements representations and issued unqualified audit reports upon the statements presented. And in all three cases, things went sour: investee exhausted its cash in what manner failed to achieve a merger and had its shares de-listed by means of the BC Securities Commission (BCSC); ClientCo carried the OvcrscasCo receivable for a year and wrote it distant from in the next audit; and Borrower declared bankruptcy shortly after FinGo released its audited statements.

BCSC announcements brought these cases to the attention of the PCEC which subsequently conclud that all three members had failed to comply with generally accepted auditing standards.

What they should have done

Case #1: The three or four-year guideline stake out in section 3050.24 requires management to provide persuasive evidence that a decline is temporary. It does not allow for this grace period when a preponderance of evidence put in mind ofs that the value will not recover

Case #2: The ClicntCo auditor rightly asked for financial statements of OverseasCo, if it be not that erred in issuing the audit report without at all times seeing them. Had he insisted forward seeing the statements before signing on the farther side he would have learned that OverseasCo had no record of auspicious operations and had insufficient resources to pay its debt

Case #3: Similarly, the FinCo auditor should have sought further evidence concerning Borrower's financial position.

The message

The PCEC recognizes that the scenarios described in this article are difficult singles for an auditor; however, the fact remains that the public (and regulators) clearly anticipate auditors to exercise considerable professional skepticism. to such a degree before you issue an unqualified audit report forward statements presented to you through your clients management, ask yourself single in kind last time: "Have I obtained enough corroborating evidence of crucial management representations?"