Lakeside case 8
Discussion Questions- Case 8
2) An over count of ending inventory would lead to a decrease in costs of goods sold which leads to an increase in net income. Anytime a company wants a higher net income there is the potential for over counting of inventory. This potential problem is especially significant in the audit of the Lakeside stores because manager’s of the each store get a bonus based on the store’s net income. They are also the same people who count the inventory. It would be very tempting for the managers to over-count their inventory in order to increase their bonus.
3) An undercount of ending inventory would lead to an increase in cost of goods sold which leads to a decrease in net income. A company may undercount inventory to defer payment of income taxes. This problem is more likely to occur to a company struggling with their cash flow. This potential problem is not especially significant to the Lakeside stores unless they wanted to reduce their current taxes.
4) In the engagement letter given to a client it says that “the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected.1” This means the auditor is not responsible for ensuring there is not mistakes or misstatement but they are responsible for reasonable assurance. The judgment of the auditor is “required to be the informed judgment of a qualified professional person2” In other words the auditors at Chapman are judged by what the average auditor exercising due care would do. If they do this then they are providing reasonable assurance. Furthermore, Chapman must show all their work as proof that they did a thorough job auditing Lakeside and were not negligent during the audit. If the average auditor exercising due care would have detected the material misstatement then Chapman would be considered negligent in its audit of Lakeside, and Lakeside can receive payment from Chapman for any losses incurred because of Chapman’s negligence.
2) An over count of ending inventory would lead to a decrease in costs of goods sold which leads to an increase in net income. Anytime a company wants a higher net income there is the potential for over counting of inventory. This potential problem is especially significant in the audit of the Lakeside stores because manager’s of the each store get a bonus based on the store’s net income. They are also the same people who count the inventory. It would be very tempting for the managers to over-count their inventory in order to increase their bonus.
3) An undercount of ending inventory would lead to an increase in cost of goods sold which leads to a decrease in net income. A company may undercount inventory to defer payment of income taxes. This problem is more likely to occur to a company struggling with their cash flow. This potential problem is not especially significant to the Lakeside stores unless they wanted to reduce their current taxes.
4) In the engagement letter given to a client it says that “the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected.1” This means the auditor is not responsible for ensuring there is not mistakes or misstatement but they are responsible for reasonable assurance. The judgment of the auditor is “required to be the informed judgment of a qualified professional person2” In other words the auditors at Chapman are judged by what the average auditor exercising due care would do. If they do this then they are providing reasonable assurance. Furthermore, Chapman must show all their work as proof that they did a thorough job auditing Lakeside and were not negligent during the audit. If the average auditor exercising due care would have detected the material misstatement then Chapman would be considered negligent in its audit of Lakeside, and Lakeside can receive payment from Chapman for any losses incurred because of Chapman’s negligence.