Case 1.7 Lincoln Savings and Loan

Topics: Audit, Financial audit, Auditor's report Pages: 5 (1735 words) Published: June 28, 2011
Cas 1) The substance-over-form concept is explained by as a concept in which “the information shown in the financial statements and accompanying disclosures of a business should reflect the underlying realities of accounting transactions, rather than the legal form in which they appear.” They go on to explain that the main point of the concept is that “a transaction should not be recorded in such a manner as to hide the true intent of the transaction.” The concept requires or assumes that someone is attempting to deliberately hide a transaction as one that meets GAAP standards although in reality the transaction would affect the financial statements differently than reported. This form of deceit was used over and over by Lincoln S&L. The biggest example provided was on page 87 concerning the “Hidden Valley” transaction. The responsibility of the auditor is to first notify their client of this discovery. The auditor should also inform their supervisor and ensure that the transaction and any communication is fully documented. The client should then be notified that the entry should be adjusted to reflect the true outcome. If the client refuses to make this adjustment or provide a sufficient explanation as to why the will not make the change, the auditing firm has a responsibility to themselves and the stakeholders of that company to withdraw from the engagement. 3) An auditor’s examination is affected when a client has engaged in significant related party transactions due to the increased risk of fraud. SAS 45 which supersedes SAS 6 is the source of AU section 334 which discusses “related parties”. This section provides a guideline for auditors to follow so that they are satisfied with the relationship and its adherence to GAAP. Although, “FASB Statement No. 57, Related Party Disclosures [AC section R36], gives the requirements for related party disclosures”, it cannot be assumed that all related party transactions will be uncovered. Steps that an auditor can take to determine the existence of related party transactions are covered in paragraph 7.

The first steps that an auditor can take to determine that related party transactions have been properly recorded are to identify those related transactions. The procedures to identify these transactions are outlined in paragraph 8. Some of these steps are to: a) “Review the minutes of meetings of the board of directors and executive or operating committees for information about material transactions authorized or discussed at their meetings.” b) “Review the extent and nature of business transacted with major customers, suppliers, borrowers, and lenders for indications of previously undisclosed relationships.” c) “Review accounting records for large, unusual, or nonrecurring transactions or balances, paying particular attention to transactions recognized at or near the end of the reporting period.” Once the related party transactions have been identified, the auditor can apply the guidance provided in paragraph 9. This paragraph states that procedures that auditor finds necessary should be applied until they are satisfied with the occurrence of these transactions. An important note is that the auditor’s investigation should extend beyond inquiry of management. In particular, paragraph 9 states some of the follow procedures: a) “Examine invoices, executed copies of agreements, contracts, and other pertinent documents, such as receiving reports and shipping documents.” b) “Test for reasonableness the compilation of amounts to be disclosed, or considered for disclosure, in the financial statements.” c) “Inspect or confirm and obtain satisfaction concerning the transferability and value of collateral.” 5)The significance of Lincoln receiving nonrecourse notes rather than recourse notes as payment was very substantial. With a nonrecourse note the purchaser can...
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