6-26 (OBJECTIVES 6-2, 6-3) The following are selected portions of the report of management
from a published annual report.
Report of Management
Management’s Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of its Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting in accordance with accounting principles generally accepted in the United States of America. Management evaluates the effectiveness of the Company’s internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control–Integrated Framework (2013). Management, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019, and concluded it is effective.
Management’s Responsibility for Consolidated Financial Statements
Management is also responsible for the preparation and content of the accompanying consolidated financial statements as well as all other related information contained in this annual report. These financial statements have been prepared in conformity with accounting principles generally accepted in the United States, and necessarily include amounts, which are based on management’s best estimates and judgments.
a. What are the purposes of the two parts of the report of management?
b. What is the auditor’s responsibility related to the report of management?
6-27 (OBJECTIVES 6-1, 6-3) Auditors provide “reasonable assurance” that the financial state-
ments are “fairly stated, in all material respects.” Questions are often raised as to the re-
sponsibility of the auditor to detect material misstatements, including misappropriation
of assets and fraudulent financial reporting.
Required
Required
In-class
Discussion
(2) Management and those charged with governance are responsible for ensuring
that the company’s operations are conducted in accordance with all applicable
laws and regulations.
(3) The auditor provides reasonable assurance that the financial statements are free
of material misstatement due to noncompliance with laws and regulations.
(4) The auditor is expected to detect the client’s noncompliance with all laws and
regulations affecting transaction cycles under review during the audit itself.
THE AUDIT PROCESS
a. Discuss the concept of “reasonable assurance” and the degree of confidence that financial statement users should have in the financial statements.
b. What are the responsibilities of the independent auditor in the audit of financial statements? Discuss fully, but in this part do not include fraud in the discussion.
c. What are the responsibilities of the independent auditor for the detection of fraud involving misappropriation of assets and fraudulent financial reporting? Discuss fully, including your assessment of whether the auditor’s responsibility for the detection of fraud is appropriate.
6-28 (OBJECTIVE 6-4) The following information was obtained from several accounting and auditing enforcement releases issued by the SEC after its investigation of fraudulent financial reporting involving Just for Feet, Inc.:
Just for Feet, Inc., was a national retailer of athletic and outdoor footwear and apparel based in Birmingham, AL. The company incurred large amounts of advertising expenses and most vendors offered financial assistance through unwritten agreements
with Just for Feet to help pay for these advertising expenses. If Just for Feet promoted a
particular vendor’s products in one of its advertisements, that vendor typically would
consider agreeing to provide an “advertising co-op credit” to the Company to share the costs of the advertisement. Just for Feet offset this co-op revenue against advertising expense on its income statement, thereby increasing its net earnings. Although every vendor agreement was somewhat different, Just for Feet’s receipt of advertising co-op revenue was contingent upon subsequent approval by the vendor. If the vendor approved the advertisement, it would usually issue the co-op payment to Just for
Feet in the form of a credit memo offsetting expenses on Just for Feet’s merchandise purchases from that vendor. The company’s CFO, controller, and vice president of operations directed the company’s accounting department to book co-op receivables and related revenues that they knew were not owed by certain vendors, including Asics, New Balance, Nike, and Reebok. These fraudulent practices resulted in over $19 million in fictitious pretax earnings being reported, out of total pretax income of approximately $43 million. The SEC ultimately brought charges against a number of senior executives at Just for Feet and some vendor representatives.
a. What does it mean to approach an audit with an attitude of professional skepticism?
b. What circumstances related to the accounting treatment of the vendor allowances
should increase an auditor’s professional skepticism?
c. What factors might have caused the auditor to inappropriately accept the asser- tions by management that the vendor allowances should be reflected in the financial
statements?
d. Develop three probing questions related to the vendor allowances that the auditor
should have asked in the audit of Just for Feet’s financial statements
