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Contemporary Auditing Solutions to Case 1.7

In: Business and Management

Submitted By jlocarni220
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Answers to Questions

1. The substance-over-form principle states that the true economic nature of a transaction should determine how it is reported on a company’s accounting records, rather than its legal form (Donaldson, 1964). This concept aims to undercut certain transactions such as related party transactions that are solely to distort profitability, rather than a true economic transaction between two parties. The auditor is responsible for the review and testing of the client’s accounting records to see that the substance of their transactions are reflected in their records. If the substance-over-form concept is violated and the financial statements are materially misstated as a consequence, the auditor is required to issue an opinion on the client’s financial statements.

2. In accepting large, high-risk audit clients for relatively high audit fees, an audit firm may become overly dependent on this client and revenue stream. The loss of such a client may be so detrimental to the audit firm itself that the behavior of auditors may change completely. Auditors know the risk of losing this client, and may become more flexible during audit engagements. The only way to figure out if such prospective clients be avoided is to process each unique situation, and use professional judgment in deciding whether to take on a client or not.

3. This issues goes back to the substance-over-form concept. The audit should consider whether economic substance was used in accounting for these transactions. They should also consider the disclosure included in client’s financial statements, and see if these related parties were disclosed properly. An auditor should examine all documentation in connection with related party transactions such as contracts, receiving reports, invoices, etc. The auditor should also inspect actual evidence in possession of the parties to the…...

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