ZZZZ Best Case Study Answers

Case 1.9 ZZZZ Best Company, Inc
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Ernst &Whinney never issued an audit on financial statements of ZZZZ Best but did issue report on the company’s quarterly statement for the three months ending July 1986. How does a review differ from audit particularly in terms of levels of assurance implied by the auditors’ report?
The audit review takes into account inquiry as well as the analytical procedures, and it is typically less than the scope of an audit, with the auditor asserting that they did not find any material modifications that ought to be made to the financial statements. The review provides limited assurance when the entities who require the financial statements. On the other hand, the audit provides reasonable basis for which to express opinion about the financial statements, while the review does not provide a basis for expressing opinion given that the auditor does not obtain understanding of the internal control system. Since the audit provides reasonable assurance that no illegal acts or material misstatements exist, the auditor relies on inspection conformation as well as observation to obtain sufficient evidence. The review relies on analytical procedures, enquiry and other review procedures depending on the auditor’s judgment. The review is also less reliable compared to the audit that is more robust.
The quarterly review report merely provides an assurance that the financial statements are prepared in accordance to GAAP standards providing a true and fair view. Since the auditor does not does not establish the strength of the internal control system or misstatements. The reviews are also less rigorous and since there is no report on the control risk, which means that Ernst and Whinney could not reliably assess whether the material misstatements world occur even with the relevant assertions. The review report may provide information indicating the likelihood of problems occurring, but it is not sufficient enough to provide accuracy of assurance. The auditors did not assess ZZZZ Best’s internal control system, and hence they missed on identifying fraudulent activities. Overall, the audit opinion gives the assurance on the accuracy of financial statements.
Essentially, an entity needs to understand the features that differentiate the review from an audit. As such, the limited assurance is the main characteristic of reviews where there is less assurance compared on the level of assurance required in audit. It is merely designed to facilitate decision making on the conclusion, while the audit focuses on obtaining evidence to show that the financial reports are not materially misstated. In the review the opinion is expressed negatively while the audit is expressed positively that they believe there is no material misstatement of the financial statements. Equally, the feedback for an audit is more detailed compared to a review since the audit is more thorough.
SAS No. 31, “Evidential matter,” identifies the five-management assertions that underlie a set of financial statements. The existence assertion was particularly critical for ZZZZ Best’s insurance restoration contracts. ZZZ Best’s auditors obtained third-party confirmations to support the contracts, reviewed available documentation, performed analytical procedures to evaluate the reasonableness of the revenues recorded on the contracts and vested restoration sites. Comment on the limitations of evidence that these procedures provide with regard to the management assertion of existence.
The assertions on existence look into whether assets, liabilities as well as interest exist at a particular date in the balance sheet. As such, both physical assets and those without physical substance are relevant to consider in the assertion of existence. The ZZZZ Best auditors sought confirmation from third parties with regards to existence of insurance restoration contracts. However, at the time there was no reasonable belief that there was collaboration between Minkow and the third-party to lie about the existence of contracts. At the same time, the auditors performed analytical procedures to assess the reasonableness of revenues recorded. In any case, they visited the restoration sites; even if they failed to evaluate the extent of the supposed damage to the restoration sites they tried to verify the existence of the restoration site.
Even though, the auditors relied on documentation and analytical procedures to prove the existence of revenue, there was limit on the extent to which they could obtain information from the third parties. The non-disclosure agreement meant that Tom Padget who was directly involved in the fraudulent schemes, and provided misleading information that could not be corroborated. Both Assured Property Management and the Interstate Appraisal Services gave documentation on transactions. Hence, collusion among the third parties limited the reliability and accuracy of audit evidence.
Even though, the supposed receipt of payments to ZZZZ Best, occurred there was no third party to prove the existence of these payments. In any case, the payments never existed even after being paid in paper. The issue that the customer and client colluded to make false statements shows the need to have written confirmation from the client. Additionally, there is a need for more visits to client site as well as communication to clients through face to face, with surprise visits likely to provide vital information about the clients activates. Barry Minkow made arrangements prior to the audit to fool the auditors since he had prior information about their intention to ensure the assertion of existence was adequate. The information presented by ZZZZ Best was insufficient to support the reasonableness of revenue from one client. In any case, the relationship with the customer should have aroused suspicion given the huge percentage for which ZZZZ Best depended on a particular client. However, there was also limitation on the relationship between costs and revenues as there were no detailed previous financial statements for which the auditor could compare results to identify and huge discrepancies on revenue.
Besides existence with, what other management assertions, if any, should ZZZZ Best’s auditors have considered corroborating for the insurance restoration contracts? Identify audit procedures that would have been appropriate to substantiate these assertions?
The assertion of occurrence is relevant to ensure that the recorded transactions did take place and is closely related to existence which focuses more on account balances. There were limitations on gathering evidence to show the occurrence of the transactions as they were disclosed by ZZZ Best. The conformation on revenue was sent to Tom Padgett the co-conspirator in the fraudulent scheme, being paid by Minkow. George Greenspan relied on information presented by Padgett based on the assumption that information from outside entities is more reliable. However, given the revenues associated with one customer, Greenspan would probably would have exercised due diligence to send out information to other entities to confirm occurrence of the transactions. In any case, all the documentation appeared to be internal further casting doubt on the appropriateness of the revenue amount recorded.
Analytical procedures may be unreliable for the assertion of occurrences in the venue balances since forgery and fraud may be hard to detect at first. The analytical procedures look into the account balances rather n that if the transactions really took place. Minkow colluded with the company’s clients to prepare restoration sites which were purported to be locations related to the insurance restoration contracts. There was limitation on evidence upon visiting the restoration site since the building owner did not confirm the assertions made by Minkow. However, the site view should rely on a valuer to assess the extent of the supposed damage that required insurance restoration. Comparing the company’s financial ratios with those of the industry was prudent, but not enough to provide information on occurrence of revenue.
Conformations on existence and occurrence provide sufficient and reliable information provided there are no third party relations and collusions. However, since the auditors agreed to confidentiality restriction, it was harder to identify the existence of fake restoration contracts and receivables. As such, identifying the key parties in the insurance contract would hav...