Case 5-4 Audit Client Considerations
Lanny Beaudean joined the CPA firm of Cardinal & Coyote LLP in 2008 after
working for two years for the IRS in Phoenix, Arizona. The firm is a secondtier CPA firm just below the Big Four in size. Beaudean had passed all four
parts of the CPA Exam in Arizona and decided to work for a locally based
CPA firm with international clients to gain a broad base of experience that
might help him become a CFO at a public company in the future. Beaudean
has been advancing rapidly and just became a senior at Cardinal & Coyote.
Yancy Corliss is a new audit partner at Cardinal & Coyote. One day Corliss
was summoned to the office of Sharon Rules, the managing partner of the
firm. Rules told Corliss that she had been approached by a new client, Jost
Furniture International. Jost is a large southwestern chain of home furniture
rental catering to young upscale individuals who might live in a city for two
years or so and then move on. It recently opened an office in Canada and
plans to expand to Europe in the not-too-distant future. Top management at
Jost seemed to imply that the firm would get the audit as long as it
submitted a reasonable bid.
Rules asked Corliss to do background checks on Jost and make whatever
inquiries were necessary to assess the potential business risk of Jost as a
future client. Corliss was given three days to do the work and report back to
Rules with a recommendation. If the decision is to go ahead, then Cardinal
& Coyote would submit a bid and compete with one other CPA firm for the
account. The firm believes it will be a lucrative account, especially since the
company has been in an expansion mode and will require advice on
acquisitions and other advisory services in the future.
Corliss assembled his team to review the background and other information
about Jost Furniture. Corliss asked Beaudean to head up the assessment
and report back to Corliss in two days. During that time, Beaudean would
have two other staff members to help with the assignment. Beaudean was
excited about his first opportunity to work on new client assessment.
Beaudean met with Vinnie Gabelli, a transplanted Brooklyn native who had
graduated from Arizona State University (ASU) at Phoenix. Gabelli was like
a fish out of water in Arizona even though he had spent 16 months in the
master’s of accounting program at ASU. Gabelli thought a prickly pear was
someone who could not make it in Staten Island and moved to Brooklyn for
a better life.
Gabelli told Beaudean that he welcomed the opportunity to work with a
native of Phoenix and learn about its colorful history. Beaudean also asked
Jackie Oloff, a native of Minneapolis, to join the team. Jackie had moved to
Phoenix two years ago with her husband, who is a professor of accounting
at ASU. The team discussed mutual responsibilities, data sources for the
information, key areas of risk, and then they broke up to start their work. At
the end of the day, the team reassembled to share information. Here is a
brief list of the findings:
1. The predecessor firm had helped Jost Furniture with its initial
public offering and audited the financial statements of the company for
five years. The firm resigned the account in 2007, following the issuance
of a modified opinion on the 2006 financial statements. The firm had
issued an unqualified opinion with an explanatory paragraph that raised
questions about the ability of Jost to continue as a going concern because
of persistent operating losses that threatened the company’s ability to
secure needed financing.
2. A second firm audited the financial statements for 2007. That firm
also raised going-concern questions and was dismissed by Jost’s top
3. Jost’s financial statements for 2008 and 2009 were audited by a
third firm that was dismissed after two years.
4. The financial statements for 2010 had not been audited and on
March 19, 2011, the CEO of Jost Furniture, Jerry Jost, approached Sharon
Rules at a community event and asked her to submit a bid for the Jost
audit. Jost asked that the bid be submitted by March 23.
5. A memorandum to the file prepared by Rules indicated that Jost had
admitted to Rules that the company had past problems with various
auditors, but Jost assured Rules the going-concern issues had been
resolved. He also told Rules that the company’s controller had recently
quit, the third time in four years there had been a turnover at that
position. Jost told Rules the company had two candidates and he wanted
her to help with the final decision since the CPA firm would work closely
with the controller.
6. Beaudean, with the help of Gabelli and Oloff, reviewed the financial
statements of Jost Furniture for the past four years during which time
going-concern explanatory paragraphs had been issued. They went
through a checklist of risk assessment issues for new clients and stopped
when they came to the following: Verify the circumstances of any prior
auditor dismissal or withdrawal by first asking the client for permission to
approach the predecessor auditor(s). All three auditors felt this should be
done by Yancy Corliss.
At the meeting at the end of the first day, the auditors discussed the unusual
number of auditor changes in a short period of time apparently due to
going-concern issues that were raised in the audit reports for the years
2006 through 2009. Beaudean asked Gabelli to contact the two banks where
the company does business and check into its payment record. Oloff had a
past business relationship with Miles Frazer, the attorney for Jost Furniture.
Oloff agreed to contact Frazer to determine whether there are any
outstanding litigation issues or other legal matters that the firm should
know about. They all agreed to get these matters done by the end of the
second day and a meeting was set for 5:00 p.m.
Gabelli found out that a $1 million loan payable to Phoenix Second National
Bank had been overdue before payment had been made March 15, 2011.
The president of the bank told Gabelli that Jost had been in violation of a
debt covenant agreement that obligated Jost to maintain a current ratio of
1.5:1 at all times and that the bank was concerned about Jost’s ability to
continue as a going concern, pointing out that Jost had gone below the ratio
twice. The first time Jost had violated the covenant, the bank accepted the
explanation of a temporary cash flow problem. The bank granted the
company a three-month extension to meet the requirements of the debt
covenant. The bank subsequently found out the cash flow problem had been
due to the fact Jerry Jost withdrew $500,000 from the Jost cash account at
Second National Bank to help put a down payment on a mortgage loan to
buy an upscale house in Scottsdale. The second time it occurred, the bank
began foreclosure on the loan on January 31, 2011, but by the time the
process had been completed, Jost had paid off the entire $1 million balance.
Oloff had no luck with the Frazer, the attorney for Jost. When she called his
offices, the secretary always told Oloff that Frazer was on another line and
she’d take a message. When Oloff asked to leave a voice-mail message, she
was told Frazer did not have voice mail. How about leaving an e-mail
message? she asked. No e-mail either. Can I text him, tweet him, or just do
it the old-fashioned way and set up an appointment? No, no, no were the
answers. Oloff had left five messages for Frazer in the time before the
meeting. She had nothing to report except to make an editorial comment
about lawyer responsiveness, or lack thereof.
At first, Jost had side-stepped Corliss’s request for permission to speak with
the predecessor auditor. Jost claimed that there had been a “personality
conflict” and Jost was afraid the auditor would speak negatively about the
company. Jost did agree after Corliss reminded him it was a required part of
the procedures auditors follow in making the client acceptance decision.
At 5:00 p.m. on March 22, the auditors met in the firm’s conference room to
discuss their findings. After hearing about Gabelli’s concerns and Oloff’s
lack of success with Frazer, Beaudean expressed serious concerns about
taking on Jost as a client.
Complete Case 5-4: Audit-Client Considerations, page 247.
Read the above case. Choose one of the individuals in the case and identify their
actions and viewpoints. Write up an executive summary on the case, including answers
to the following questions.
Brief review of the case from your auditor’s point of view (one paragraph)
Identification of the key behaviors, attitudes, and ethical dilemmas faced by or
caused by the auditor
Assessment of the philosophical and practical approaches to ethical decisionmaking that could have avoided the problems in the case
Evaluation of alternatives to solve the situation in the case
Summary of actions that you might have taken yourself if you had been in this
situation in real life