Abernathy and Chapman
Wallace Andrews Lakeside
1235 Sentry Drive
Richmond, Virginia 66266
Dear Mr. Wallace,
We have researched the issues that were discussed regarding the possibility of Lakeside Company going public and the ramifications this action would have on their desirability as a client. We have also analyzed Lakeside Company’s financial statements to evaluate the possibility of misstatements. Attached, you will find our report discussing these issues.
Please contact us with any further questions.
Cc: Bob Zimmerman
Case Two: New Clients, Legal Liability and Materiality
Table of Contents
Apply Your Research9
Consulting Partner Review13
The Impact of Sarbanes-Oxley15
Abernethy and Chapman have to consider whether to accept new client. To do this they created a three-partner committee to screen these new clients. A partner in charge is assigned to each of the potential clients and is driven by guidelines set out by this three-partner committee. An analysis of potential legal liability must be performed for each of these potential clients. The partner in charge that is assigned to assess these clients is asked specific questions that were designed by the committee. A couple of the questions that are asked are: Is the potential client privately held or publicly held? Evaluate the possible legal liability to third parties, both present and potential, that Abernethy and Chapman might incur if the engagement is accepted. Another form that the partner in charge must complete is regarding information from predecessor auditors. All of this information is necessary in determining whether to take on this potential client. This form provides information about what a predecessor auditor’s evaluations where as well as seeing what the predecessor auditor’s understanding was pertaining to the reason for a change in auditors. Materiality of a company must also be looked at and reviewed. A base for establishing misstatements is necessary because materiality is relative. A review to see if there is a material misstatement can reflect on the integrity of management if there is fraud involved.
1. King and Company faces a materiality question in forming its year 2011 audit opinion. How do auditors evaluate the materiality of an item in a specific engagement? Do you believe that the possible impairment of the investment sixth store was actually material to the Lakeside Company?
Materiality is an important factor in determining appropriate audit reporting. Auditors must consider materiality and its relationship with audit risk when conducting an audit. In order to avoid any material misstatement within the company’s financial statements, auditors must perform an audit so as to provide them with sufficient evidence that would give a factual and a fair view for those parties relying on the financial statements. Materiality is defined by FASB Concept Statement 2 as: “The magnitude of the omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.“ (Arens p. 270) Because financial reporting usually results from approximate measurements, though often based on rules and conventions rather than exact measurements; and financial statements reflect a combination of known information that is reported on a historical basis; judgments about current values including estimates of the effects of future events on measurements recorded at the present time. As a result, auditors must use their professional judgment to a situation in order to determine if a materiality issue exists.
In order to evaluate the materiality...