Case 1.9 ZZZZ Best Company, Inc.
1. A review is similar to an audit but is less in scope and only provides limited assurance in regards to the presentation of the financial statement. This differs with an audit that gives reasonable assurance that no material errors or illegal acts are detected. The objective of an audit is to provide a reasonable basis for expressing an opinion regarding the financial statements taken as a whole. A review does not provide a basis for the expression of such an opinion because a review does not involve obtaining an understanding of the internal control structure or assess control risk, tests of accounting records and of responses to inquiries by obtaining corroborating evidential matter through inspection, observation or confirmation, and certain other procedures ordinarily performed during an audit. A review mostly involves inquires of client personnel and analytical procedures. In a review an accountant does not give an opinion as to the fair presentation of the financial statements, reasonable assurance. Instead the accountant states that no material modification came to his/her attention in order for the statements to be in conformity with generally accepted accounting principles, limited assurance.
2. As it relates to the assertion of occurrence and existence, third-party confirmations are usually highly reliable and auditors normally seek these out for a complete audit. While these forms of evidence can be reliable this isn’t always the case as such evidence can be direct or indirect. Direct third party confirmations are those that are mailed and received directly from the third party e.g. a bank confirmation or an account receivable confirmation mailed directly to the auditors. The indirect confirmation is less reliable since it passes through the clients’ hands e.g. a bank statement or an accounts receivables confirmation faxed to the client and forwarded to the auditors. Reviewing available documentation such as contracts are reliable sources of evidence but as with indirect confirmations they pass through the hands of the clients and can be doctored or fabricated, as was the case with the insurance restoration contract. Analytical procedures to evaluate revenues are less suited for the assertion of occurrence since account balances can be fictitious or incorrect. Such procedures involve looking at relationships amongst account balances and does not address whether such transactions occurred. Normally site visits are the most reliable evidence for the assertion of occurrence & existence. I don’t believe there are many limitations to this procedure unless a client is as willing as ZZZZ Best co. was in spending millions of dollars to purport a false site as their own.
3. Such apparent reliable evidence, as confirmation of payment, can lead an auditor to wrongfully conclude the occurrence of the contract because collusion is hard to detect and is one of those inherent risk in every audit. Greenspan might have checked invoices and confirm the receipt of payment but if Minkow and Tom Padgett, CEO of both their companies, are working together and purporting a false transaction then it is very unlikely that an auditor will detect such a business relationship.
4. The predecessor-successor auditor communication is essential to accepting a new client. The successor auditor is the only party with the responsibility to initiate communication. They cannot contact the predecessor auditor directly and must go through the client. The client can then grant permission to the successor to contact the predecessor or they can arrange a meeting with all parties present. As per AU 315.07 “Inquiry of the predecessor auditor is a necessary procedure because the predecessor auditor may be able to provide information that will assist the successor auditor in determining whether to accept the engagement. The successor auditor should bear in mind that, among other things, the predecessor auditor and the client may have disagreed about accounting principles, auditing procedures, or similarly significant matters.” As explained in AU 315.09, the successor auditor is to obtain information;
1. bearing on the integrity of management,
2. regarding disagreements that occurred with management regarding accounting principles, auditing procedures and other significant matters,
3. communicated to those charged with governance regarding fraud, illegal acts and internal control matters
4. about the predecessor’s understanding as to the change in auditors.
5. I do believe Minkow’s confidentiality letter was in fact a client-imposed scope limitation. It’s quite okay for a client to request confidentiality of its records but the second request was very restrictive and related less to confidentiality of ZZZZ Best’s business and more to the gathering of evidence by the auditors. A questioning mind should raise much doubt about management’s integrity in such case. In essence, Minkow was saying we reserve the right to take you the auditor to any building being restored and you are not allowed to ask any questions. The letter didn’t allow the auditors to verify any information about the site with the building owner or the insurance company, therefore not allowing the auditors from obtaining reliable evidence from independent third parties. A confidentiality request from the client is acceptable as long as it does not greatly limit the work of the auditors. In some cases client will want to safeguard their assets or their research and development. In such case the auditor will want to make sure he isn’t hiring a specialist who is aligned to the client’s competitor. So in this case the audit plan would have properly been affected. Client-imposed scope limitations can result in a disclaimer of opinion or a qualified opinion when the auditors are not able to perform alternative procedures that would satisfy an unqualified opinion. Normally any client imposed limitations should be a red-flag and should immediately bring doubts to the auditors mind as to management’s representation.
6. There are no requirements in the professional standards regarding pre-audit but post-year-end earnings press releases. However, it is suggested that it is common practice for clients to allow auditors to review such release before making it public.