Case 1
1. Arthur Young was criticized for not encouraging Lincoln to invoke the substance-over-form principle when accounting for its large real estate transactions. Briefly describe the substance over form concept and exactly what it requires. What responsibility, if any, do auditors have when a client violates this principle? Substance-over-form is an accounting principle used to ensure that financial statements give a complete, relevant, and accurate picture of transactions and events. If an entity practices substance-over-form, then the financial statements will show the overall financial reality of the entity.
This concept becomes even more relevant when transactions may not be made at arms-length, often involving related parties. This was the case with Lincoln Savings and Loan complex real estate transactions. Arthur Young should not have accepted the questionable documentary evidence provided by Lincoln employees to corroborate the savings and loan’s real estate transactions.
Auditors have a responsibility when a client violates the substance-over- principle. The auditor should be examining and testing client transactions to ensure this principle is not being violated. If a discrepancy is discovered, it needs to be considered in terms of the overall effect on the client’s financial statements. If the misstatement is material, it must be corrected or the auditor needs to issue a qualified or adverse opinion.
2. Explain how the acceptance of large, high-risk audit clients for relatively high audit fees may threaten an audit firm's de facto and perceived independence. Under what circumstances such prospective clients should be avoided?
When an auditing firm’s clients are large, high-risk clients for relatively high audit fees, there is a risk that independence will be compromised if it has the potential to end the relationship with a profitable high-risk client. Add to this, the client having a high audit risk, and it has the potential to make the audit
This concept becomes even more relevant when transactions may not be made at arms-length, often involving related parties. This was the case with Lincoln Savings and Loan complex real estate transactions. Arthur Young should not have accepted the questionable documentary evidence provided by Lincoln employees to corroborate the savings and loan’s real estate transactions.
Auditors have a responsibility when a client violates the substance-over- principle. The auditor should be examining and testing client transactions to ensure this principle is not being violated. If a discrepancy is discovered, it needs to be considered in terms of the overall effect on the client’s financial statements. If the misstatement is material, it must be corrected or the auditor needs to issue a qualified or adverse opinion.
2. Explain how the acceptance of large, high-risk audit clients for relatively high audit fees may threaten an audit firm's de facto and perceived independence. Under what circumstances such prospective clients should be avoided?
When an auditing firm’s clients are large, high-risk clients for relatively high audit fees, there is a risk that independence will be compromised if it has the potential to end the relationship with a profitable high-risk client. Add to this, the client having a high audit risk, and it has the potential to make the audit