Rene Ritter opened a small grocery and related-products convenience store in 1989 with money she…

Rene Ritter opened a small grocery and related-products convenience store in 1989 with money she had saved working as an A&P store manager. She named it Ritter Dairy and Fruits. Because of the excellent location and her fine management skills, Ritter Dairy and Fruits grew to three locations by 1994. By that time, she needed additional capital. She obtained financing through a local bank at 2 percent above prime, under the condition that she submit quarterly financial statements reviewed by a CPA firm approved by the bank. After interviewing several firms, she decided to use the firm of Gonzalez & Fineberg CPAs, after obtaining approval from the bank. In 1998, the company had grown to six stores, and Rene developed a business plan to add another 10 stores in the next several years. Ritter’s capital needs had also grown, so Rene decided to add two business partners who both had considerable capital and some expertise in convenience stores. After further discussions with the bank and continued conversations with the future business partners, she decided to have an annual audit and quarterly reviews done by Gonzalez & Fineberg, even though the additional cost was almost $25,000 annually. The bank agreed to reduce the interest rate on the $4,000,000 of loans to 1 percent above prime. By 2003, things were going smoothly, with the two business partners heavily involved in day-to-day operations and the company adding two new stores each year. The company was growing steadily and was more profitable than they had expected. By the end of 2002, one of the business partners, Fred Worm, had taken over responsibility for accounting and finance operations, as well as some marketing. Annually, Gonzalez & Fineberg did an in-depth review of the accounting system, including internal controls, and reported their conclusions and recommendations to the board of directors. Specialists in the firm provided tax and other advice. The other partner, Ben Gold, managed most of the stores and was primarily responsible for building new stores. Rene was president and managed four stores. In 2008, the three partners decided to go public to enable them to add more stores and modernize existing ones. The public offering was a major success, resulting in $25 million in new capital and nearly 1,000 shareholders. Ritter Dairy and Fruits added stores rapidly under the three managers, and the company remained highly profitable under the leader – ship of Ritter, Worm, and Gold. Rene retired in 2011 after a highly successful career. During the retirement celebration, she thanked her business partners, employees, and customers. She also added a special thanks to the bank management for their outstanding service and to Gonzalez & Fineberg for being partners in the best and most professional sense of the word. She mentioned their integrity, commitment, high-quality service in performing their audits and reviews, and considerable tax and business advice for more than two decades.


a. Explain why the bank imposed a requirement of a quarterly review of the financial statements as a condition of obtaining the loan at 2 percent above prime. Also explain why the bank didn’t require an audit and why the bank demanded the right to approve which CPA firm was engaged.

b. Explain why Ritter Dairy and Fruits agreed to have an audit performed rather than a review, considering the additional annual cost of $25,000.

c. What did Rene mean when she referred to Gonzalez & Fineberg as partners? Does the CPA firm have an independence problem?

d. What benefit does Gonzalez & Fineberg provide to stockholders, creditors, and management in performing the audit and related services?

e. What are the responsibilities of the CPA firm to stockholders, creditors, management, and other users?

(Objective 6-1)


Auditing standards indicate

Rene Ritter opened a small grocery and related-products convenience store in 1989 with money she had...-1

Our primary focus is the section that emphasizes issuing an opinion on financial statements. For some public companies, the auditor also issues a report on internal control over financial reporting as required by Section 404 of the Sarbanes–Oxley Act. Auditors accumulate evidence in order to reach conclusions about whether the financial statements are fairly stated and to determine the effectiveness of internal control, after which they issue the appropriate audit report. If the auditor believes that the statements are not fairly presented or is unable to reach a conclusion because of insufficient evidence, the auditor has the responsi bility of notifying users through the auditor’s report. Subsequent to their issuance, if facts indicate that the statements were not fairly presented as in the ZZZZ Best case, the auditor will probably have to demonstrate to the courts or regulatory agencies that the audit was conducted in a proper manner and the auditor reached reasonable conclusions.

Rene Ritter opened a small grocery and related-products convenience store in 1989 with money she had...-2

(Objective 6-3)


Auditing standards state

Rene Ritter opened a small grocery and related-products convenience store in 1989 with money she had...-3

This paragraph discusses the auditor’s responsibility for detecting material mis – statements in the financial statements. When the auditor also reports on the effectiveness of internal control over financial reporting, the auditor is also responsible for identifying material weaknesses in internal control over financial reporting. The auditor’s respon – sibilities for audits of internal control are discussed in Chapter 10. This paragraph and the related discussion in the standards about the auditor’s responsibility to detect material misstatements include several important terms and phrases. Material Versus Immaterial Misstatements Misstatements are usually considered material if the combined uncorrected errors and fraud in the financial statements would likely have changed or influenced the decisions of a reasonable person using the statements. Although it is difficult to quantify a measure of materiality, auditors are responsible for obtaining reasonable assurance that this materiality threshold has been satisfied. It would be extremely costly (and probably impossible) for auditors to have responsibility for finding all immaterial errors and fraud. Reasonable Assurance Assurance is a measure of the level of certainty that the auditor has obtained at the completion of the audit. Auditing standards indicate reasonable assurance is a high, but not absolute, level of assurance that the financial statements are free of material misstatements. The concept of reasonable, but not absolute, assurance indicates that the auditor is not an insurer or guarantor of the correctness of the finan – cial statements. Thus, an audit that is conducted in accordance with auditing standards may fail to detect a material misstatement. The auditor is responsible for reasonable, but not absolute, assurance for several reasons:

1. Most audit evidence results from testing a sample of a population such as accounts receivable or inventory. Sampling inevitably includes some risk of not uncovering a material misstatement. Also, the areas to be tested; the type, extent, and timing of those tests; and the evaluation of test results require significant auditor judgment. Even with good faith and integrity, auditors can make mistakes and errors in judgment.

2. Accounting presentations contain complex estimates, which inherently involve uncertainty and can be affected by future events. As a result, the auditor has to rely on evidence that is persuasive, but not convincing.

3. Fraudulently prepared financial statements are often extremely difficult, if not impossible, for the auditor to detect, especially when there is collusion among management. If auditors were responsible for making certain that all the assertions in the state – ments were correct, the types and amounts of evidence required and the resulting cost of the audit function would increase to such an extent that audits would not be economically practical. Even then, auditors would be unlikely to uncover all material misstatements in every audit. The auditor’s best defense when material misstatements are not uncovered is to have conducted the audit in accordance with auditing standards. Errors Versus Fraud Auditing standards distinguish between two types of misstate – ments: errors and fraud. Either type of misstatement can be material or immaterial. An error is an unintentional misstatement of the financial statements, whereas fraud is intentional. Two examples of errors are a mistake in extending price times quantity on a sales invoice and overlooking older raw materials in determining the lower of cost or market for inventory. For fraud, there is a distinction between misappropriation of assets, often called defalcation or employee fraud, and fraudulent financial reporting, often called manage – ment fraud. An example of misappropriation of assets is a clerk taking cash at the time a sale is made and not entering the sale in the cash register. An example of fraudulent financial reporting is the intentional overstatement of sales near the balance sheet date to increase reported earnings. Professional Skepticism Auditing standards require that an audit be designed to provide reasonable assurance of detecting both material errors and fraud in the financial statements. To accomplish this, the audit must be planned and performed with an attitude of professional skepticism in all aspects of the engagement. Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence. Auditors should not assume that management is dishonest, but the possibility of dishonesty must be considered. At the same time, auditors also should not assume that management is unquestionably honest. Auditors spend a great portion of their time planning and performing audits to detect unintentional mistakes made by management and employees. Auditors find a variety of errors resulting from such things as mistakes in calculations, omissions, misunder – standing and misapplication of accounting standards, and incorrect summarizations and descriptions. Throughout the rest of this book, we consider how the auditor plans and performs audits for detecting both errors and fraud. Auditing standards make no distinction between the auditor’s responsibilities for searching for errors and fraud. In either case, the auditor must obtain reasonable assurance about whether the statements are free of material misstatements. The standards also recognize that fraud is often more difficult to detect because manage – ment or the employees perpetrating the fraud attempt to conceal the fraud, similar to the ZZZZ Best case. Still, the difficulty of detection does not change the auditor’s responsibility to properly plan and perform the audit to detect material misstatements, whether caused by error or fraud. Fraud Resulting from Fraudulent Financial Reporting Versus Misappro – priation of Assets Both fraudulent financial reporting and misappropriation of assets are potentially harmful to financial statement users, but there is an important difference between them. Fraudulent financial reporting harms users by providing them incorrect financial statement information for their decision making. When assets are misappropriated, stockholders, creditors, and others are harmed because assets are no longer available to their rightful owners.

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