Question

3.60 Client Selection. You are a CPA in a regional public accounting firm that has 10 offices in three states. Mr. Shine has approached you with a request for an audit. He is president of Hitech Software and Games Inc., a five-year-old company that has recently grown to $500 million in sales and $200 million in total assets. Shine is thinking about going public with a $25 million issue of common stock, of which $10 million would be a secondary issue of shares he holds. You are very happy about this opportunity because you know Shine is the new president of the Symphony Society board and has made quite a civic impression since he came to your medium-size city seven years ago. Hitech is one of the growing employers in the city. Required: page 116 a. Discuss the sources of information and the types of inquiries that you and the firm's partners may make in connection with accepting Hitech as a new client. b. Do professional audit standards require any investigation of prospective clients? c. Suppose Shine also told you that 10 years ago his closely held hamburger franchise business went bankrupt, and on investigation, you learn from its former auditors (your own firm in another city) that Shine was fraudulent in its application of franchise-fee income recognition rules and presented such difficulties that your firm resigned from the audit (before the bankruptcy). Do you think the partner in charge of the audit practice should accept Hitech as a new client?

Answer 1

Answer:-

a. The sources of information and types of inquiries may include:

Financial information prepared by the prospective client

                        Annual reports to shareholders.

                        Interim financial statements.

                        Securities registration statements.

Annual report on SEC Form 10‑K.

                        Reports to regulatory agencies.

Inquiries directed to the prospect’s business associates

                        Banker.

                        Legal counsel.

                        Underwriter.

                        Other persons (e.g., customers, suppliers).

Predecessor auditor, if any, communication regarding

                        Integrity of management.

                        Disagreements with management.

           

            Analysis

                        Special or unusual risk related to the prospect.

                        Need for special skills (e.g., computer or industry expertise)

Internal search for relationships that would compromise independence

In addition, auditors can search business press articles and stories and legal files on the Lexis-Nexis system or on the Internet for news about chairman of the board, the CEO, the CFO, and often other high-ranking officers. Auditors can engage an outside search firm (private investigators) to conduct additional searches for information. Auditors are looking for information about client risk factors: companies accused of fraud, subjected to SEC or other regulatory investigation, changed auditors frequently, and incurred recent losses.

b.         Yes. AICPA Quality Control Standards require firms to investigate all prospective audit clients.

c.         Students can decide this acceptance question either way although the brief facts prejudice the conclusion toward non-acceptance. The CPA’s own firm decided to resign only 10 years ago, presumably over matters of owner–manager integrity, yet, Mr. Shine appears to be a respected member of his new community. Maybe his cavalier accounting attitude is behind him. Then again, maybe it is not. This is something that the auditor will have to determine.