1. Should auditors evaluate the soundness of a client’s business model? Defend your answer. The auditor’s responsibility is not to evaluate a client’s business model but to have a sufficient understanding of the entity. An auditor needs a sound and comprehensive understanding of the client’s business and industry to develop valid expectations about financial-statement assertions.
2. Identify and briefly describe the specific fraud risk factors present during the 2000 NextCard audit. How should these factors have affected the planning and execution of the engagement?
The three examples of risk factors (a) pressure, (b) opportunities, and (c) rationalizations. Nextcard‘s pressure was in rapid growth by extending credit of more than $1 billion to customers without profits but rather large losses. The need to raise additional debt or equity capital when the Internet bubble burst and their stock prices went downward continued to cost rather than bring in revenue. Jeremy Lent and his executives dominated the organization and created ineffective monitoring and concealed the extent of the entities financial problems. NextCard’s executives understated credit losses and refused to provide sufficient allowances for expected bad debts. The third risk factor relates to rationalizations by Lent and his executives to increase Nextcard’s stock price rose from a selling price of $20 per share to more than $40 thus making them instant multimillionaires. The executives also continued to promise and predict that they would turn the corner to eventually report a profit. Instead of making a profit NextCard and the executives concealed the extent of the company’s financial situation by understating the allowance for credit losses. These three factors should have affected the planning and execution of the engagement had the audit team understood the business they were auditing. If the audit team had researched previous audit records, contacted the Comptroller of the...
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