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Auditing: preparation of personal financial statements

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You are a credentialed CPA just starting your own practice in Hollywood, California, after five years' experience with a "Big 4" firm. You have several connections in the entertainment industry and hope to develop a practice rendering income tax, auditing, and accounting services to celebrities and other wealthy clients.

One of your first engagements is arranged by John Forbes, a long-established business manager for a number of celebrities, and a friend of yours. You have been hired to audit the personal statement of financial condition (balance sheet) of Dallas McBain, one of Forbes's clients. McBain is a popular rock star with a net worth of approximately $100 million. However, the star also has a reputation as an extreme recluse who is never seen in public except at performances.

Forbes handles all of McBain's business affairs, and all your communications with McBain are through Forbes. You have never met McBain personally and have no means of contacting the star directly. All of McBain's business records are maintained at Forbes's office. Forbes also issues checks for many of McBain's personal expenses, using a check-signing machine and a facsimile plate of MacBain's signature.

During the audit, you notice that during the year, numerous checks totaling approximately $500,000 have been issued payable to Cash. In addition, the proceeds of a $250,000 sale of marketable securities were never deposited in any of McBain's bank accounts. In the accounting records, all of these amounts have been charged to the account entitled "Personal Living Expenses." There is no further documentation of these disbursements.

When you bring these items to Forbes's attention, he explains that celebrities such as McBain often spend a lot of cash supporting various "hangers-on," whom they don't want identified by name. He also states, "Off the record, some of these people also have some very expensive habits." He points out, however, that you are auditing only the statement of assets and liabilities, not McBain's revenue or expense. Furthermore, the amount of these transactions is not material in relation to McBain's net worth.

1.Discuss whether the undocumented disbursements and the missing securities proceeds should be of concern to you in a balance sheet-only audit.

2.Identify the various courses of action that you might at least consider under these circumstances. Explain briefly the arguments supporting each course of action.

3.Explain what you would do and justify your decision.

4.Assume that you are a long-established CPA, independently wealthy, and that the McBain account represents less than five percent of the annual revenue of your practice. With this change in circumstances what you would do? Discuss.

5.Consider that you are not independently wealthy. How would this affect what you would do?

6.Finally, what are the issues embedded in this case that influence or alter your understanding of accounting control systems? What does this now suggest about accounting control systems?

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Solution Preview

1. Any concern over disbursements relates to an income statement or change in net worth statement. These types of statements are rarely, if ever, presented as part of the personal financial statement. Since a balance sheet looks at financial position at a given point in time, there is rarely any discussion about where assets came from or why liabilities are there. There are other types of engagements which would address the expenditures: a special engagement with agreed upon procedures or a fraud audit are two types. Both are beyond the scope of the current engagement.

2. Concerns over the possibility of fraud could prompt a CPA to withdraw from the engagement, although that is not a well thought-out response. A better solution might be to prepare an engagement letter which carefully defines the parameters of the work to be done. Second, a letter of representation signed by the client (not the agent) should be required. Third, the type of opinion should be carefully discussed together with an explanation of procedures required at each level of attestation. Fourth, there should be discussion about who the users of the financial statement would be and their level of need.

3. I would have a discussion with the agent ...

Solution Summary

The solution is a comprehensive 800 word discussion in response to the questions posed. Each of the six questions has a direct response plus additional general cited material at the end. After reading the solution, the reader will have a clear understanding of the issues relating to the preparation of personal financial statements by CPAs.

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Sample audit program

Newham, Inc.
Test of Controls Results - Revenue
December 31, 2015

Of the 213 sales transactions examined, 82 "deviations" were identified:

• No credit approval was found on 42 sample items
• The wrong quantity billed was identified on five sample items
• There was a mathematical error on 10 sample items
• No shipping document could be located for 25 sample items

Following are the procedures used:

1. We randomly chose the sample of 216 transactions across the year with 18 from each calendar month.
2. All of the invoices in the sample were found. None were missing.
3. All of the invoices were properly posted to the general ledger sales and accounts receivable control accounts, and each was posted to the right customer's individual account.

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