You are a young 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 personal friend of yours. You are engaged to audit the personal statement of financial condition (balance sheet) of Dallas McBain, one of Forbe'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 Forbe's office. Forbes also issues checks for many of McBain's personal expenses, using a check-signing machine and a facsimile plate of McBain's signature.
During the audit, you notice that during the 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 not further documentation of these disbursements.
When you bring these items to Forbe'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 expenses. Furthermore, the amount of these transactions is not material in relation to McBain's net worth.
a. Discuss whether the undocumented disbursements ant the missing securities' proceeds should be of concern to you in a balance sheet-only audit.
b. Identify the various course of action that might at least consider under these circumstances. Explain briefly the arguments supporting each course of action.
c. Explain what you would do and justify your decision
d. Assume that you are a long-established CPA, independently wealthy, and that the McBain account represents less than 5 percent of the annual revenue of your practice, Would this change in circumstances affect your conclusion in part (c)? Discuss.
This is how I would approach each of your homework study questions:
(A) The undocumented disbursements and the missing securities proceeds would be of concern, even though it is a balance sheet audit. First of all, securities are assets, which would appear on the balance sheet as either long term or short term assets, depending on the asset type, so it isn't correct that the securities would not affect the balance sheet. The proceeds would affect the income statement, but just as with a company, the securities would be listed as assets on the balance sheet. Because of the very unethical, unprofessional, and illegal way that the client's assets are being handled by Forbes, the auditor should discuss this with the client directly. The mishandling of expenses does affect the balance sheet indirectly, because the net income flows from the income statement onto the balance sheet. Also, as part ...
This solution provides an analysis of undocumented disbursements and missing securities proceeds, and discusses the financial and non-financial/ethical consequences of the CPA's decisions.