The US Surgical Case:
1. Identify audit procedures that, if employed by Ernst & Whinney during the 1981USSC audit, might have detected the overstatement of the leased and loaned assets account that resulted from the improper accounting for assets retirements.
There are several audit procedures that, if employed by Ernst & Whinney during the 1981 USSC audit, might have detected the overstatement of the leased and loaned assets account that resulted from the improper accounting for assets retirements. First of all, Ernst & Whinney overlooked an important risk factor of the company’s strong incentive to reach targeted sales and profit goals. In addition, they failed to properly apply analytical procedures during the planning phase. They also overlooked several material changes in USSC account balances from the end of 1980 to the end of 1981. USSC leased, rather than sold, many of its surgical tools. The company’s accounting staff recorded the cost of these assets in a subsidiary fixed asset ledger, lease and loaned assets. USSC periodically retired such assets and removed their accounts from the sub-ledger. However, SEC investigators discovered that in many cases the costs associated with these assets were not removed from the sub-ledger but instead debited to the accounts of other assets still in service. The auditors could have used key financial ratios that are used in analytical procedures to detect the overstatement.
2. In 1981, USSC extended the useful lives of several of its fixed assets and adopted salvage values for many of these same assets for the first time. Are these changes permissible under generally accepted accounting principles? Assuming these changes had a material effect on USSC’s financial condition and results of operations, how should the changes have been disclosed in the company’s financial statements? How should these changes have affected Ernst & Whinney’s 1981 audit opinion? (Assume that the current audit reporting standards were in effect at the time.)
There are some situations where this can be within the guidelines of GAAP. According to APBO Number 20, which was applicable during the 1981 audit period, changes in accounting estimates for asset salvage values and useful life are permissible when updated information is made available that reflects more accurate data and estimates. Currently FASB Statement Number 154 states, “This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. If we assume that these changes are material to the financial statements, then at a minimum, a separate footnote to the financial statements should outline this change. Information such as what depreciation would have been before the change in estimate should be presented along with the current methodology. Also the impact on net income or loss should be disclosed. The changes without the disclosures should have changed Ernst & Whinney’s 1981 audit opinion away from an unqualified opinion.
3. Prepare common-sized financial statements for USSC for the period 1979-1981. Also, compute key liquidity, solvency, activity, and profitability ratios for 1980 and 1981. Given these data, identify what you believe were the high-risk financial statement items for the 1981 USSC audit. | | | | | | | | | |
| | | | | 1981| | 1980| | 1979|
Current Assets:| | | | | | |
| Cash| | | 0.2%| | 1.0%| | 0.8%|
| Receivables (Net)| | 17.7%| | 25.6%| | 32.0%|
| Inventories:| | | | | | |
| | Finished Goods| | 14.1%| | 8.3%| | 8.1%|
| | Work In Process| | 2.5%| | 2.2%| | 1.6%|
| | Raw Materials| | 10.1%| | 15.8%| | 10.4%|
| | | | | 26.7%| | 26.3%| | 20.1%|
Other Current Assets| | 3.8%| | 1.3%|...