Case 5. 3 The North Face, Inc 1 Auditors should not insist that their clients accept all proposed audit adjustments even those that have an “immaterial” effect on the given set of financial statements. Because “immaterial” effect on the financial statements will not affect the users’ decisions. Therefore, auditors have to confirm if the effects on the financial statements are really “immaterial”. If there are really “immaterial”, sometimes the auditor would be forced by the clients to ignore it.
So the auditor should give the client suggestions on why they recommend for the client to make adjustments. If the client disagrees with the adjustments, they maybe have a logical reason for why they don’t want to make the adjustments. The auditor should respect the client’s decision since the items have no material effect on the financial statements. 2 Auditors should take explicit measures to prevent their clients from discovering the materiality threshold used on individual audit engagements.
Because it leaves the opportunity for unethical clients to manipulate the specific records that auditors looking for to conceal the material misstatements. The clients can use these information to impair an audit engagement or an individual’s audit procedures. It is not feasible for auditors to conceal this information from their clients, especially when they are dealing with material information. It will increase the difficulty of auditors to detect the material errors in the client’s financial statements, because audit would not be able to rely on the client’s documents and information. Revenue should be recognized based on accrual accounting in accordance with GAAP. It should be recognized when earned, regardless of the timing of cash receipts. Deposits, early payments and progress payments should not be recognized as revenue until the revenue has occurred. Barter transaction is the transaction that a company receives trade credits in exchange for merchandises, it should be recorded at the fair value of the merchandise given up. Though the exchange value of this element is recognized, the fair alue on the excess merchandise that was sold to the barter company was clearly questionable. And a large portion of the 9. 3 millions dollars that was recorded for the consignment sales was improper because it violated SFAS No. 48 (Revenue Recognition When Right of Return Exist). It was not a real exchange because the two customers did not pay for their merchandises and the transactions were not finalized until the customers resells the merchandise. 4 Audit documentation serves mainly to: (AU 339. 03) Provide the principal support for the auditor’s report, including the representation regarding observance of the standards of fieldwork, which is implicit in the reference in the report to generally accepted auditing standards. b Aid the auditor in the conduct and supervision of the audit. All of these two objectives above were undermined by Deloitte’s decision to alter North Face’s 1997 workpapers. First, when Borden reviewing the 1997 audit workpapers, he discovered the audit adjustment that Pete had proposed during the prior year audit to reverse the 1. 4 million barter transaction. He destroyed audit evidence, prepared a new summary memorandum and adjustments schedule reflecting the revised conclusion about profit recognition, and replaced the original 1997 working papers with these newly created working papers. Second, Borden relied on this assertion during the 1998 audit. Thus, the auditors reached an improper decision on the accounting treatment in January 1998. 5 It depends on different situations. Generally, the overall quality of executive’s decisions affects the “inherent risk” during an audit work.
If the key decisions involve obvious frauds, auditors have responsibility to assess them. Three conditions generally are present when fraud occurs. One is “management or other employees have an incentive or are under pressure, which provides a reason to commit fraud. ” (AU 316. 07) Even otherwise honest individuals can commit fraud in an environment that imposes sufficient pressure on them. The greater the incentive or pressure, the more likely an individual will be able to rationalize the acceptability of committing fraud. But if there is no obvious frauds exist, auditors don’t have the responsibility.