B. O. ACC650 Case 7.1 – Ligand Pharmaceuticals

1. Describe what you believe is implied by the term “engagement risk.” What are the key factors likely considered by Deloitte and other audit firms when assessing engagement risk? How, if at all, are auditors’ professional responsibilities affected when a client poses a higher than normal degree of engagement risk?
Engagement risk is composed of three broad categories: the entity’s business risk, the auditor’s audit risk, and the auditor’s business risk. Each subtopic has its corresponding factors in regards to an audit. * Entity’s Business Risk
“Financial trends are the most important part of [an] entity’s business risk (Ethridge).” The main business risk of an entity is that their continuity is threatened. Furthermore, they may not be profitable to continue doing business in the future.
As an example in this case, Ligand Pharmaceuticals’ stock price increased by 600% within one year ($4/share in early 2003 to $24/share in early 2004), despite not ever reporting an operating profit. Stock prices are a thin barrier to use, and the volatility of the market could cause Ligand to collapse due to insufficient funding. There is another example of entity business risk in the case where Ligand Pharmaceuticals had questionable accounting of its sales returns, because although wholesalers had the right to return any products, they did not “sell through” to their customers. An increase in return allowance could throw off the balance sheet as well as the stated income. “Special” treatment of accounts can mask or pad losses, so audit partners and staff must be aware of surrounding risks of misstatement, whether intentional or unintentional. In the case of Ligand accountants, they lacked experience in dealing with these kind of entries, so there was a significant amount of risk allocated to the related sales returns