Subject: Lack of client transparency
Services: Audit
Auditor Joe Lister was invited to audit the 2018 financial statements of the Summit’s (a condominium association’s) financial statements. Acceptance of the proposal was contingent upon satisfactory discussions with the predecessor auditor
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. The Summit accepted the proposal.
The dialogue with the predecessor auditor was open, transparent and helpful, and Lister was engaged to perform the audit. The predecessor auditor was responsive and cooperative as Lister planned the audit of the Summit’s 2018 financial statements.
Several months later, but prior to commencing the audit, Lister had extensive discussions with the Summit’s general manager (“GM”) and its bookkeeper, Edith Brady. During those discussions Lister was informed of fraud and legal issues that had prompted the termination of a staff member responsible and the filing of police reports. The terminated staff member had opened credit cards in the Summit’s name and used the cards for personal expenditures. The estimated fraudulent damages were approximately $50,000.
The GM also informed Lister that several improper billing practices, which had been long suspected, were determined to have been ongoing for over a decade.
The engagement took on a life of its own as accounting issues, internal control issues and journal entries piled up. The accounting issues identified were exacerbated by the change in accounting staff and a change in GMs. During the engagement period, the board continued to revise its calculations of the billing errors, and the annual shortfall grew from $500K to $2M. In response, the board approved revised assessment collection guidelines and agreed not to penalize or pursue unit holders for billing inaccuracies that resulted in $10M+ in underbilled assessments.
In August, Lister was informed by the Summit’s new GM that the police and the board’s finance committee hoped to use the audit opinion to validate the fraud issues. Lister pushed back, contrasted the objectives of a financial statement audit with that of a forensic investigation, and asserted that it would be unreasonable for the Summit to expect the audit opinion to provide sufficient evidence to support the police investigation or validate actions taken by the Summit’s board and finance committee. The GM acquiesced, but his actions and comments suggested that he and the board expected to utilize the audit report as evidence to support their actions.
In early September, Brady informed the auditor that the successor GM had resigned. Brady provided no explanation or details of the GM’s abrupt departure. Seeking an explanation for the GM’s departure, Lister attempted to reach the Summit’s finance committee chair, Sam Smithers. Smithers took two weeks to respond, acknowledged the GM had resigned, provided no explanation for the GM’s departure, volunteered that the Board president had also resigned, and noted that the Summit’s bylaws would permit a future board to rescind the decision not to pursue the underbilled assessments.
Asked whether any fraudulent or otherwise inappropriate behavior was suspected, Smithers stated that he didn’t believe so, but minimal investigation had been done. Requests to receive copies of the GM’s and board president’s letters of resignations were fruitless, and Smithers stated that he would need to first consult with the Summit’s legal counsel.
A week later, Lister presented a draft of the Summit’s 2018 financial statements to Smithers and reiterated that the audit would not be finalized until copies of the letters of resignation were provided, and concerns were relieved regarding (1) the departures of the Summit’s GM and president, and (2) any fraud issues. In response, Smithers gave Lister an email from the Summit’s legal counsel noting that “no fraud concerns” were identified in an “internal review.”
The internal review was not a forensic investigation; conspicuous by their absence were any discussion of the recent departures of the president or GM and any reference to the sought letters of resignation. Lister’s concern grew as a result of: (1) the continued obfuscation regarding the recent departures, (2) the Summit having consulted outside counsel, and (3) the Summit conducting an internal review instead of engaging someone qualified to perform a forensic examination.
Lister was being pressured by the Summit to “wrap up” the audit. He also learned that a member of his audit team was contacted by the former GM, who claimed that she had not resigned, was terminated due to the billing issues, and had filed a complaint against the Summit with the Equal Employment Opportunity Commission (“EEOC”). Concerns regarding these issues prompted Lister to seek advice from CAMICO’s Loss Prevention hotline.
After reading each of the following questions, select the one answer under each issue that you believe is the best response.
Issues
1. If you were Lister, would you be concerned regarding the integrity and trustworthiness of the Summit’s Board and Finance Committee?
Yes [Preferred answer]
No [Not the preferred answer]
2. If you were Lister, would you be concerned that the Summit expects the audit opinion to provide validation for the Summit’s Board’s actions regarding billing abnormalities and the alleged fraudulent activity?
Yes [Preferred answer]
No [Not the preferred answer]
3. If you were Lister, would you be concerned regarding the possibility that the Summit’s Board or Finance Committee wishes to use your audit report to downplay the fraud and billing issues?
Yes [Preferred answer]
No [Not the preferred answer]
Assuming the financial statements are adjusted to reflect all the adjusting entries you believe are necessary to address GAAP exceptions for the billing issues related to revenues, receivables and the opening equity for impacts on previous years, and any past adjustments are not material …
4. If you were Lister, would you believe the financial statements warrant an unmodified opinion?
Yes [Not the preferred answer]
No [Preferred answer]
5. If you were Lister, would you believe the financial statements warrant a qualified opinion due to the potential magnitude and uncertainty of the billing issues, fraud issues, and lack of responsiveness of Summit management regarding the departure of key individuals?
Yes [Not the preferred answer]
No [Preferred answer]
6. If you were Lister, would you believe the financial statements warrant an adverse opinion due to the potential magnitude and uncertainty of the billing issues, fraud issues, and lack of responsiveness of Summit management regarding the departure of key individuals?
Yes [Not the preferred answer]
No [Preferred answer]
7. Would Lister be justified in disclaiming an opinion?
Yes [Not the preferred answer]
No [Preferred answer]
8. What grounds could Lister use to support disengaging?
Uncertainty [Not the preferred answer]
Management integrity issues [Not the preferred answer]
Independence impaired [Not the preferred answer]
All of the above [Preferred answer]
9. If you were Lister, would you disengage?
Yes [Not the preferred answer]
No [Preferred answer]
10. If Lister were to wish to disengage, should Lister disengage now or wait until after issuing?
Disengage now [Not the preferred answer]
Disengage after issuing [Preferred answer]
11. If not disengaging, what report/opinion (if any) would you provide?
Unmodified [Not the preferred answer]
Adverse opinion [Not the preferred answer]
Disclaimer of opinion [Not the preferred answer]
No opinion [Preferred answer]
CAMICO/Policyholder Dialogue
Has Lister considered the audit evidence supporting management’s analysis of the material misstatements regarding the billing and fraud issues?
Is Lister satisfied with management’s calculations of the material misstatements?
What audit procedures were performed on the opening balances given these issues to address the possible effect of prior misstatements?
Did Lister or management communicate with the predecessor auditor about these potential misstatements?
Has management agreed to recall the previously issued financial statements?
Either Summit or Lister should contact the predecessor auditor to alert them to the potentially material misstatement of the Summit’s previous years’ financial statements so that the predecessor auditor may consider whether to recall their audit opinions. 2
Given the issues encountered by Lister, and the obvious severe weaknesses in the system of internal control (issues involving the control environment and control activities section of the system), are the Summit’s 2018 financial statements unauditable or so severe a scope limitation that a disclaimer of opinion would be required if not disengaging?
In light of the issues encountered, the enormity of the adjustments, and the significant management turnover that has required significantly more work and judgment by Lister, has Lister’s independence been impaired?
Does Lister believe current management has the skill, knowledge and experience to take responsibility for the work Lister performed?
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Does Lister perceive adverse interest4, self-interest5, self-review6 or undue influence 7
threats to his independence?
Conclusion
Lister concluded that independence was impaired due to (1) perceived lack of independence due to the quantity and significance (dollar amounts) of the journal entries and related work,
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(2) the combination of adverse interest, undue influence, self-review financial self-interest threat
threats and a
that might be perceived as influencing him to subordinate his judgment were he to consider issuing an opinion, and (3) management had not put in place sufficient controls (policies or procedures) to mitigate these threats to an acceptable level.
Auditors are precluded from disclaiming an opinion when not independent unless auditing standards provide for an exception.
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This means Lister can’t issue a disclaimer of opinion but does NOT mean that Lister can’t provide the Summit with the fruits of his terminated engagement. The Summit can’t receive an opinion or even a disclaimer of opinion, but Lister can and should write a detailed disengagement letter indicating why the audit was terminated and addressing issues encountered during the engagement.
Ultimately, Lister determined that his independence was impaired, and he recognized that he could not disclaim an opinion. He chose to write a letter acknowledging his independence was impaired, why it was impaired, stating that his impaired independence necessitated he disengage from the audit, and stating that he is:
- writing to disengage from the audit,
- highlighting the issues encountered,
- encouraging the Summit to recall its prior years’ financial statements,
- detailing the significant matters and internal control issues identified (matters addressed in communications with those charged with governance 10 and communications of internal control related matters identified 11),
- attaching the financial statements prepared in conjunction with the terminated audit engagement,
- adding a statement to each page of the accompanying financial statements and any footnotes stating, “no assurance is provided on these financial statements,”
- expressing a willingness (if engaged to do so) to assist the Summit with addressing the issues Lister had identified, and
- offering to cooperate as necessary with a successor accountant.
Lister need not engage to perform an AR-C 70 preparation of the Summit’s financial statements but could choose to do so. Regardless, Lister determined that he was not prohibited from providing the Summit with the financial statements, and although he had not been engaged to perform an AR-C 70 preparation of the Summit’s financial statements, he elected to provide the Summit with financial statements with a footer on each page that read “No assurance is provided on these financial statements.” This is the same legend he uses on his AR-C 70 preparation of financial statement engagements.
“War Stories” are drawn from CAMICO claims files and illustrate some of the dangers and pitfalls in the accounting profession. All names have been changed.
1 Sample predecessor auditor clause: We will require written authorization from you permitting your predecessor CPA to speak openly with our firm. By your signature below, you understand and agree that our firm’s acceptance of this engagement and the terms and conditions as specified in this letter are contingent upon receiving satisfactory responses to these inquiries.
2As written, the Summit’s authorization received during the client acceptance process would permit Lister to alert the predecessor auditor to the issues encountered.
3ET1.295.040.01 a.ii
4ET 1.290.12
5 ET 1.290.16
6ET 1.290.17
7ET 1.290.18
8ET 0.300.050.01 A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.
9AU-C 200.15
10AU-C 260
11AU-C 265
