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The client’s knowledge of the materiality thresholds that the auditor may apply when auditing the firm is very risky. The client may subvert the intention of the auditing procedures or may as well sabotage the integrity of the whole audit engagement.
Since auditors may acquire the client personnel documents so as to save costs as they perform other audit-related activities and prepare schedules for conducting the audit, the client may interfere with the entire process. The client may conceal some critical information from the auditor thereby decreasing the sample size for the audit, thus lowering the auditor’s materiality decisions.
The client is likely to present misstatements in organization’s financial statements. The client may also interfere with the evidence by manipulating the items of the financial statements leading to insufficient or misleading evidence during auditing. This is likely to interfere with the auditor’s judgment of the business risks that the client is engaged in (Strayer University, 2010).
In North Face Company, Crawford was the company’s chief financial officer that concealed fraud from North Face Inc. independent auditors in 1997 by not informing them of the oral side agreements made between him and the barter company.
Crawford’s knowledge of the materiality thresholds which Deloitte auditors would apply in auditing the company’s financial statement items and the adjustments that they would propose regarding the $1.64 million trade credits made him include the transaction, but did not inform the auditors of the $2.65 until after the completion of the 1997 audit.
Katz who was the company’s sales vice president also arranged for the signing of fake purchase orders by the two customers who owned substantial amounts of North Face Inc.’s merchandise to deceive the auditors that the two customers actually owned the merchandise (Knapp, n.d).
Guidelines for Revenue Recognition
The guidelines that determine when a company is to record revenue are that the exchange transaction should be complete and again the production earning process should also be complete. This means that the goods must be manufactured and delivered to the client and payment must be received either in cash or receivables at the point of sale.
According to Turner (2001), revenue should only be recognized after they have been realized and recognized by the company. For the revenue to be considered as realized and earned, there should be evidence that the arrangements exists; delivery should have taken place; the seller’s and the buyer’s prices should be determinable; and finally, collectability should be reasonably assured (Turner, 2001).
In the North Face Company, Crawford structured the $7.8 million transaction to recognize trade credits which are barter transactions as profit. Crawford instructed North Face’s accountants to record the trade credits of $1.64 million and $2.65 million as profit even though the oral agreements involved payments in phases.
Besides the payments involved, barter transactions cannot be recognized as revenues, meaning that the exchange transaction was not complete by the time the North Face recognized the revenues as profit. The company later reacquired the inventory in 1999 (Knapp, n.d).
Objectives of Work Papers
Its primary objective is to document all the audit procedures performed by the auditor or the auditing team. The procedures documented in the work paper should connect the flow of the information as well as the conclusions in the concluding audit report. Accurate and credible work paper provides the foundation for audit and the subsequent reporting.
It must contain the specific tasks performed as well as the observations and information acquired through inquiry. It has to contain the specific individuals consulted as well as the supporting documents and detailed narratives to support the information contained in the corresponding audit report (Strayer University, 2010).
The revision of the work papers that was done by Deloitte personnel in 1997 to replace the original work papers made new summary memorandum as well as adjustments schedule without documenting revisions in the work papers. Thus the revised 1997 work papers could not show that the revising team reached a different conclusion from the original team concerning North Face’s 1997 barter transactions (Knapp, n.d).
The Auditor’s Responsibility
The auditor’s role is to detect and prevent fraud in an organization’s business processes. They therefore have to evaluate the financial projects as well as the anticipated financial projects that the organization is about to enter and as such, provide reliable and timely feedback on the feasibility and the risks involved in the project.
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The external and internal auditors measure the effectiveness of the executives’ decisions as well as the internal controls put in place by the executives. The auditors assess the quality of the decisions of the executives on the financial activities of the company and therefore determine their competence (Knapp, n.d).
They assess the financial reporting of the company and provide guidance for improving the internal control system to ensure that the company achieves operational as well as strategic objectives. Both the internal and external auditors focus on enabling the organization to provide reliable financial reporting.
The internal auditors are therefore involved in continuous control monitoring as well as in continuous auditing of the organization’s business processes (Zabihollah, 2002).
Knapp, M. C. (n.d). The North Face, Inc.: An instruction case focusing on ethical issues involving financial accountants and independent auditors. Oklahoma: University of Oklahoma.
Strayer University (2010). ACC 599: Graduate accounting capstone. Mason, OH: Cengage Learning Custom.
Turner, L. E. (2001). Speech by SEC staff: Revenue recognition. US Securities and Exchange Commission: USC SEC and Financial Reporting Institute. Retrieved from https://www.sec.gov/news/speech/spch495.htm
Zabihollah, R. (2002). Financial statement fraud: Prevention and detection. New York: Wiley & Sons.