Reference no: EM132287495

Rae & Wong, Beyond Integrity, 3rd Ed. (Zondervan) 2012, ISBN: 9780310291107

Audit Adjustments:

You are a CPA on the audit staff of a multinational public accounting firm. You are the senior auditor on an annual audit of a manufacturing company that is a small subsidiary of a larger company that is a significant client of your firm. In addition to a sizable fee for the annual audit, the parent company pays your firm additional fees each year for tax consultation and return preparation as well as other management consulting services. With this particular audit, as with many parent-subsidiary relationships, you are aware that there is a tremendous amount of pressure on the subsidiary company’s management to reach certain projected sales goals for the year. Because of this, the climate at the subsidiary is tense as you begin your annual examination of the year-end financial statements. During the course of the audit, you perform a sales cutoff test to ensure that all sales transactions at year-end were recorded in the proper period. Since title to the company’s products passes when they are shipped to customers, shipments are required in order for a sale to be properly recorded. Accordingly, a standard audit procedure is to cross-reference sales recorded prior to year-end to related shipping records to sales journals. The sales cutoff test revealed that numerous shipments made after the company’s year-end were recorded as sales prior to year-end, which resulted in significantly higher revenue during the year you are auditing. You are aware that as an independent auditor, you have a responsibility to your clients and to those who might make decisions based on the company’s financial statement, such as investors and lenders. When you inform the subsidiary’s controller of the results of your sales cutoff test and that an adjustment to annual revenues and profits would likely be warranted, he takes the matter to the president of the subsidiary. During a follow-up meeting with the controller and president, the president attempts to get you to reconsider your proposed adjustment with the following arguments.

1) The amount of the adjustment you were proposing was not material to the parent company’s financial statement.

2) All of the subsidiary’s competitors did the same thing in recording shipments just after year-end as sales in the previous year.

3) It really didn’t matter in the long run if sales were moved from the current year to the next year, since sales and profits for the next year would be greater

At the end of the meeting, the president drops a not-so-subtle reminder that his company is a substantial client of the firm. You call the partner from your firm who is in charge of the audit for advice, and he tells you to handle the situation on your own. After considering all factors, you continue to feel that an adjustment to the company’s financial statements is warranted, but after a meeting with the client attended by your senior partner on the audit (and not attended by you) you are instructed by the senior partner not to make the adjustment.

How should you react?