An analysis of Instructional Case Focusing on Ethical Issues
Involving Financial Accountants and Independent Auditors
1.Should auditors insist that their clients accept all proposed audit adjustments, even those that have an “immaterial” effect on the given set of financial statements? Defend your answer.
To confirm that materiality is a pervasive concept in auditing, simply refer to the index of the professional auditing standards and identify the large number of “materiality” entries—approximately fifty, if you are curious. In addition to being an important topic, materiality is easily among the most controversial auditing topics. And, no more topic is as controversial as the issue of how to assess the materiality of proposed audit adjustments near the conclusion of an audit engagement. The most explicit guidance on this matter in the professional standards is contained in AU 312.34-41. Following is an excerpt from AU 312.38-39.
If the auditor concludes, based on the accumulation of sufficient evidential matter, that the effects of likely misstatements, individually or in the aggregate, cause the financial statements to be materially misstated, the auditor should request management to eliminate the misstatement. . . . If the auditor concludes that the effects of likely misstatements, individually or in the aggregate, do not cause the financial statements to be misstated, he or she should recognize that they could still be materially misstated because of further misstatements remaining undetected.
Given the guidance provided by the professional auditing standards, I would suggest that the most reasonable answer to this case question is, “No, not necessarily.” Clearly, auditors’ lives would be less complicated if clients would prepare an adjusting entry for each proposed audit adjustment. However, clients are not prone to adopting that mindset or strategy, which forces auditors to somehow determine on an aggregate basis the impact that proposed and/or passed audit adjustments have on a client’s financial statements. You might point out that a client typically has a rational reason for not making a proposed audit adjustment, the most common being that the client disagrees with the need for the given adjustment.
You might also want to point out to your students that critics of the auditing discipline claim that many audit engagements ultimately become a tug-of-war between client management and auditors over proposed audit adjustments. These parties commonly suggest that the leverage client executives have over their auditors allow them to sometimes “bully” or force auditors to pass on audit adjustments that should be recorded in the client’s accounting records.
2.Should auditors take explicit measures to prevent their clients from discovering or becoming aware of the materiality thresholds used on individual audit engagements? Would it be feasible for auditors to conceal this information from their audit clients?
To the greatest extent possible, auditors should not provide clients with access to the critical parameters or facets of audit engagements, including materiality limits. Similar to what transpired in this case, unethical client personnel can use that information to subvert the intent of individual audit procedures or even the integrity of the entire audit engagement. Having said that, it is often not feasible to conceal information such as materiality limits from client personnel. For example, to mitigate the cost of an audit, auditors typically have client personnel “pull” documents, prepare various schedules to which audit procedures will be applied, and perform other important audit-related tasks. In completing these tasks, client personnel can...