Information has been collected from seven channels, either formal or informal. They are the bank, the state Insurance ComMTSsioner, some business acquaintances, colleagues in the tax department, the prior auditor who retired, the controller of MTS, and informal channel such as golfing buddies and grapevine. More information should be acquired in terms of integrity and reputation, especially those relevant to MTS as well as strategies of MTS, the development and future of time-share project. The information can be obtained from the following channels:
1. Real estate associations, real estate agents to obtain information about the current status of time-share condominiums industry 2. Both the local court and the high court to know whether MTS has any suspending lawsuits 3. The senior management in MTS to know MTS’s strategies and internal business environment 4. The key customers of MTS and major competitors in the time-share condominiums business so as to collect the information of MTS’s business performance and how well it performed in comparison with its competitors.
Based on the current and new information, a five Porter8 and PEST9 analysis should be conducted to evaluate the external and internal business environments of MTS. In getting known more about the performance and reputation of MTS in the industry, the information is more relevant and reliable to make the decision of whether to perceive MTS as a prospective client or not. 2. 4. Reasons for not undertaking the auditing engagement of MTS If only based on the information provided in the scenario, I will decide not to accept MTS as a client for the following reasons.
Firstly, there is very likely that MTS will have integrity problem. The behaviors of MIT are strong evidence that similar issues could exist in MTS since MTS are managed and mainly owned by Jake as well. It is not reasonable or logical that the same person will behave totally different in two companies, both he is the key manager and the majority shareholder. That will increase the chance of having material fraud or illegal acts which may not be found in the auditing.
Secondly, both the current adopted aggressive accounting policies and possibility of manipulation of accounting policies in the next three years indicate the likelihood of violation of GAAP. That means additional time and efforts should be taken in the auditing process in order to acquire sufficient evidences to reduce audit risks. Moreover, conflicts and communication problems will arise due to the disagreement on the accounting practices between the auditor and MTS. 2. 5.
The most significant audit risks if taking over MTS’s auditing The most significant audit risks would be inherent risks in terms of integrity of management, misstatement of the financial statements, going concern issues, related-parties problems. The initial ratio analysis on the financial statements (Appendix 1 and Appendix 2) indicates that the Income-Producing Property grows 107%, from $13,241 in 1999 to $27,381 in 2000. The total liability of MTS doubled from $49,84410 in 1999 to $7864111 in 2000.
In particular, the mortgage payable increases 114%, from $18,717 in 1999 to $40,088 in 2000, which suggest that MTS has more projects longer than one year. That may cause cash flow difficulties to MTS. The dramatic drop of the cash balance in the bank, from $1,247 in 1999 to only $78 in 2000, is a warning signal. For the risk of going concern issues, related-parties problems, the auditor should be focused on the following area to make sure the management do not “have a bath” in 2000. The “Sales of real estate” account and “Real estate taxes” account should be audited carefully.
Because the sales decreased 23% while the taxes expense increased 15. 6%, which is not reasonable due to no change in the current tax policies. The approaches could be to follow up on significant unexpected account fluctuations, to increase the extent of testing of large and unusual transactions, to examine transactions with missing or inadequate documentations, to investigate significant discrepancies in transactions with MTS’s customers, to obtain independent confirmations of transactions with customers, bank and tax department.
For the risk of misstatement of the financial statements and potential violation of GAAP, “Depreciation and Amortization expense accounts”, “Real estate under development”, “Real estate held for investment” and “treasury stock” accounts should be paid attention to. Since the value of Property and Equipment increased almost 21% but the depreciation expense only increased 0. 58%. There is a dramatically loss to the treasury stock accounts, which was $565,000 dollars, comparing with the zero balance both in 1999 and 1998. Those are the accounting areas that should be focused on and drilled down to find the reasons.
The approaches could be to visit multiple locations for both the real estates under development and held for investment, to interview with the accountants in MTS to see whether accounting principles are being misused, to follow up on significant unexpected account fluctuations, to increase the extent of testing of large and unusual transactions.
3. Conclusion The above analysis suggests that Murphy Tymshare should not be accepted as an auditing client to the firm due to its higher audit risks in terms of integrity, poor reputation, aggressive and potential manipulation of accounting policies and potential financial problems.But if accepted, much more efforts and attention should be taken to collect sufficient audit evidences to protect the auditor from audit risks.
Knechel, W. R. (2001). Auditing: Assurance & risk. (2nd ed). Cincinnati, Ohio : South-Western College Pub. Appendix 1: Appendix 2: 1 The seven factors are expertise and staffing, independence, integrity, reputation and image, accounting practices, financial status and profitability.
The first two factors are within the control of the auditor, while the last five factors are beyond the control of the auditor and must be evaluated regarding the acceptability of a client. 2 As the first two factors, expertise and staffing, and independence can be controlled and managed by the auditor, they are ignored in the discussion. 3 “have a bath” means that the managers know that they are unlikely to get bonus due to the current low profits so that they hide a proportion of profits to a later year so that they can both get bonus and earn money out of the share market due to the increased share price.