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Issues with the case

PROBLEM:
Subsequent to year-end, the auditors have determined that they believe that management has understated its warranty obligations. The auditors know that, according to AU 312.36, they should consider the difference between management's estimate and the closest reasonable estimate as "likely misstatement." The chief financial officer (CFO) has agreed that this amount is reasonable. Yet, in fact neither the auditors nor the CFO know which amount is right. The CFO is under no particular pressure to meet an earning forecast; he just thinks that the warranty obligations for many of the products will expire and will not be exercised. Still, the CFO can't convince the auditors. Likewise, the auditors can't convince the CFO of their position. The CFO finally agrees to a material adjustment to get the auditors' amount and "keep the peace."

REQUIRED:
What are the embedded issues within the case?

How might the strategies employed either ensure the success of the organization or establish parameters that can lead to exceptions in the accounting control system, creating undue risk?

State the highest level of deficiency that you believe these circumstances represent?a control deficiency, a significant deficiency, or a material weakness. Explain your decision.

Solution Preview

Accounting PROBLEM:

Subsequent to year-end, the auditors have determined that they believe management has understated its warranty obligations. The auditors know that, according to AU 312.36, they should consider the difference between management's estimate and the closest reasonable estimate as "likely misstatement."

The chief financial officer (CFO) has agreed this amount is reasonable. Yet, in fact neither the auditors nor the CFO know which amount is right. The CFO is under no particular pressure to meet an earning forecast; he just thinks that the warranty obligations for many of the products will expire and will not be exercised. Still, the CFO can't convince the auditors. Likewise, the auditors can't convince the CFO of their position. The CFO finally agrees to a material adjustment to get the auditors' amount and "keep the peace."

REQUIRED:

* What are the embedded issues within the case?

The embedded issues within the case appear to be ethically related coupled with financial and policy issues. According to the AICPA, "The auditor should also consider whether the difference between estimates best supported by the audit evidence and the estimates included in the financial statements,
which are individually reasonable, indicate a possible bias on the part of the entity's management. For example, if each accounting estimate included in the financial statements was individually reasonable, but the effect of the difference between each estimate and the estimate best supported by the audit evidence ...

Solution Summary

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