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Conflict of Interest: Audit Firms and Clients

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Do you believe that a public accounting company can be truly independent if they are being paid by the client to audit the financial statements? Or is there an inherent conflict of interest in such an arrangement? Is there a better way to pay the auditors?

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Good question, and the truth is that anyone expecting to be paid for a service is probably not independent from the person making the payment. That might include dentists, carpenters, roofers, lawyers, etc. but it is our accepted mode of doing business.

The real question then is how do purchasers of any service insure that they will be treated fairly. Depending on the type of service, there are licensed sellers, there are local, state and federal agencies ...

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The 300 word solution discusses audit conflicts and independence with regard to fees charged for audited financial statements.

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You are a partner in the Denver office of a national public accounting firm.

You are a partner in the Denver office of a national public accounting firm. During the audit of one of your clients, you learn that this client is negotiating to sell some of its unproved oil and gas properties to a large investment company, which is an audit client of your New York office.

Your client acquired these properties several years ago at a cost of $15 million. The company drilled several exploratory wells, but found no developable resources. Last year, you and your client agreed that the value of these unproved properties had been "impaired" as defined in paragraph 28 of Financial Accounting Standards Board (FASB) 19. The company wrote the carrying value of the properties down to an estimated realizable value of $9 million and recognized a $6 million loss. You concurred with this treatment and issued an unqualified auditors' report on the company's financial statements.

You are amazed to learn that the sales price for these properties being discussed by your client and the investment company is $42 million. You cannot understand why the investment company would pay such a high price and you wonder what representations your client may have made to the investment company concerning these properties. The management of your client company declines to discuss the details of the negotiations with you, calling them "quite delicate" and correctly pointing out that the future sale of these properties will not affect the financial statements currently under audit.

Summarize the arguments for advising the investment company (through your New York office) that you consider the properties grossly overpriced at $42 million.

Summarize the arguments for remaining silent and not offering any advice to the investment company on this matter.

Express your personal opinion as to the course of action you should take. Support your perspective from the research, additional readings, and prescribed text for the course. Indicate whether the arguments for advising the investment company or remaining silent most influenced your decision. If there is a difference between your personal and professional perspectives, please indicate the rationale for the divergence.

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