The following paper will discuss the hypothetical research case given to us in problem 3-46 of our auditing textbook. The case depicts us as an audit firm that, during the current year’s audit of our client International Bank of Commerce (IBC), has discovered some problems with loans that IBC has issued. First, the standards of the AICPA Code of Professional Conduct, the ASB auditing standards, and the PCAOB auditing standards that apply to this will be identified and discussed. These standards will be used to analyze the problems in this case, as well as the likely effects of the possible courses of action we could take as a public auditing firm. From these possible actions, a best course of action will be picked.
Illegal Activities by Clients
Let’s first identify and discuss the applicable standards related to illegal activities by clients. Section 317 of the ASB Auditing Standards defines illegal acts as “violations of laws or governmental regulations. Illegal acts by clients are acts attributable to the entity whose financial statements are under audit or acts by management or employees acting on behalf of the entity.” (AU 317.02) Section 317 also states that an auditor does not normally have the professional competence to determine if an act is illegal. However, an auditor may recognize that some client acts may be illegal. (AU 317.03) In other words, even though we as auditors normally do not have the competence to say for sure if a client is acting illegally, our competency of the client’s business, industry and environment should make us aware that a client action could potentially be illegal in nature. The PCAOB Interim Standards currently uses Section 317 as a guideline for dealing with illegal acts by public company clients. As we will discuss later, even if an audit firm discovers potential illegal activities by a client, they are still bound by Rule 301 of the AICPA Code of Professional Conduct, which “prohibits a member in public practice from disclosing any confidential client information without the specific consent of the client.” (ET 301.04) This rule will not prohibit us as auditors from finding and revealing potentially illegal acts during an audit. But an auditor should always inquire about the acts to management and the company’s audit committee before considering other actions. (AU 317.10)
Related Party Transactions
Next, we will identify and discuss Section 334 of the ASB Auditing Standards, which covers related party transactions. According to the standards, “many related party transactions are in the normal course of business. In such circumstances, they may carry no higher risk of material misstatement of the financial statements than similar transactions with unrelated parties. However, the nature of related party relationships and transactions may, in some circumstances, give rise to high risks of material misstatement of the financial statements than transactions with unrelated parties.” (AU-C 550) Once a related party transaction is discovered the auditor “should then evaluate all the information available to him concerning the related party transaction or control relationship and satisfy himself on the basis of his professional judgment that it is adequately disclosed in the financial statements.” (AU 334.11) In the situation given to us, it is already assumed that we have used our professional judgment as auditors to see that some of the transactions in question are improper related party transactions that have not been disclosed in the client’s financial statements.
Problems of the Case
Now that we have identified the standards related to the case, we can move on to the problems presented in the case itself. According to the information given, during the audit we discovered that improper loans were made to stockholders and other related parties. We also found that loans were recorded on the books that appear to be either false or...