Auditor

1
Auditors Standard Report
Report of Independent Accountants To LJ
Appliances, Inc. We have audited the
accompanying balance sheet of LJ Appliances,
Inc., as of December 31, 1999, and the related
statements of income, retained earnings, and cash
flows for the year then ended. These financial
statements are the responsibility of the
Companys management. Our responsibility is to
express an opinion on these financial statements
based on our audits. We conducted our audit in
accordance with generally accepted auditing
standards. Those standards require that we plan
and perform the audit to obtain reasonable
assurance about whether the financial statements
are free of material misstatement. An audit
includes examining, on a test basis, evidence
supporting the amounts and disclosures in the
financial statements. An audit also includes
assessing the accounting principles used and
significant estimates made by management, as well
as evaluating the overall financial statement
presentation. We believe that our audit provides
a reasonable basis for our opinion. In our
opinion, the financial statements referred to
above present fairly, in all material respects,
the financial position of LJ Appliances, Inc. as
of December 31, 1999, and the results of its
operations and its cash flows for the year then
ended in conformity with generally accepted
accounting principles. Alex and Louis, CPAs Iowa
City, Iowa February 10, 2000
(responsibilities)
(scope)
(opinion)
2
Reasonable assurance and Materiality
AuR risk of materially misstated financial
statements given GAAS audit 1 -
Reasonable Assurance P( SM gt M GAAS audit)
lt AuR P( SM gt .005 Rev. GAAS audit) lt .005
3
Reasonable assurance(SECPS (AICPA))
10,000 audits per year (approximate) 100
complaints filed with SECPS per year
50 found to be GAAS violations 50
complaints when GAAS met GAAS audit failed to
find M when it existed AuR lt 50 / 10000
.005
4
Materiality
Discovery vs. Disclosure (what size misstatement
could you waive and still satisfy GAAP?)
5 to 10 of net income (adjusted for accounting
method, small firm, losses or close to zero
problem)
.5 of revenue of large firm (/- .25) 1 of
revenue of small firm (/- .5)
5
Management responsible, but has discretion

• choose transactions in which to engage
• choose methods to account for transactions and
  events
• choose how carefully to apply chosen methods
  (precision and bias of estimates and judgments)
• choose to misapply methods (non-GAAP)

6
AstroGamas

• Holds 4 million in Trasher games ( 500K units,
  cost 8, net selling price 5 to 8 (loss up
  to 3)
• Customers hold 7.5 million to 12.5 million
  Trasher
• Lower of cost or market Correction (adj.) needed?

Others say 0 to 1,500,000 write down
needed for GAAP
Actual f(contract, auditor reputation, ERM . .
.)
7
The Auditors Engagement Risk (from being
associated with entity as its auditor)
Audit Risk (Unknowingly certify material
misstated financial statements)
Client Business Risk (Future decline in
client performance)
Auditors Business Risk (Management fraud,
lawsuits, reputation loss, client noncompliance)
Note GAAS and GAAP measurement and
disclosure criteria apply.
8
Engagement Risk Approach to Financial Statement
Audits
9
Audit benefits

• Management gets
• lower cost of capital, production, distribution
• higher revenues

• Auditor gets
• audit fee
• overview of corporate operations, financing,
  (strategy?), and inside knowledge about
  problems
• access to CEO, CFO, corporate board

• Conflict between objectivity and advice

10
Five Common Conditions Accompanying Management
Misrepresentation Fraud
1. Overstatement of revenues (including early
recognition) 2. Understatement of expenses
(including delayed recognition, nonrecognition
of obsolescence or impairment, and
accounting estimate manipulation) 3. Accounting
method changes increase current year earnings
and net assets 4. Declining business prospects
for the industry (need accounting manipulation
to maintain earnings performance and
trends) 5. Management compensation based on
accounting performance measures (providing
personal financial motivation for
accounting misstatement)
11
Northern Frontier Parks, Inc.
Value (price) expected NI / cost of capital
2 million / .2 10 million
ave NI for 2001 through 2010?
NI for 2000 good approximation?
assuming GAAP for NI and no growth
12
Issues in Case 7 - NFP, Inc.

• management buyout - how does this affect audit
  and risks?
• relevance of GAAP/ year for valuation
• what risks can a GAAS audit control?
• what are audit risks for NFP 2000 audit?
• what special risks for auditor/ buyer?