You are retained by Columbia Corporation to audit its financial statements for the fiscal year ended June 30. Your consideration of internal control indicates fairly satisfactory condition, although there are not enough employees to permit an extensive separation of duties. The company is one of the smaller units in its industry, but it has realized net income of about $500,000 in each of the last three years.
Near the end of your fieldwork, you overhear a telephone call received by the president of the company while you are discussing the audit with him. The telephone conversation indicates that on May 15 of the current year the Columbia Corporation made an accommodation endorsement of a 60-day $430,000 note issues by a major customer, Brill Corporation, to its bank. The purpose of the telephone call from Brill was to inform your client that the note had been paid at the maturity date. You had not been aware of the existence of the note before overhearing the telephone call.
(A) From an ethical standpoint, do you think the auditors would be justified in acting on information acquired in this manner?
(B) Should the balance sheet as of June 30 disclose the contingent liability?
(C) Prepare a list of auditing procedures that might have brought the contingency to light. Explain fully the likelihood of detection of the accommodation endorsement.
(A) The auditors would definitely be justified in acting on the information acquired regarding the note. In fact, if the auditors chose not to act on the information, it would be a very unethical decision, because the auditors have been made aware of the information, even though it was by chance. The company basically acted as a backer or a cosigner on the other company's liability. The note was for a substantial amount, which was a two month note at $430,000, and the company that was accommodated was a major customer of Columbia Corporation. Because this is a major customer, we also have an issue where the company does not want to lose the customer, and if the company has no sense of ethics, they will likely do whatever is needed to retain the customer. It is doubtful that a liability of this size was left off of Columbia's balance sheet in error, which indicates that unethical decisions have been made to keep the note off the balance sheet. The auditors need to act ethically, and determine the circumstances surrounding this very serious misstatement in the company's financial statements. The auditors need to follow proper protocol. If they do not act on the information, they are in violation of the AICPA, GAAS (generally accepted ...
Using Columbia Corporation, the solution considers the ethical standpoint for the auditors.