Nextcard, Inc. Case Study

...

What are the primary objectives an audit team hopes to accomplish by preparing a proper set of audit workpapers?

Audit workpapers are essential documents that are results of audit engagements. These papers are considered to be part of the audit documentation. With this, auditors follow specific standards in handling their working papers. According to Auditing Standard No. 3 Audit Documentation, the objective of this preparing a proper set of audit workpapers is to improve audit quality and enhance public confidence in the quality of auditing. Good audit documentation improves the quality of the work performed in many ways. First, it can provide a record of actual work performed, which provides assurance that the auditor accomplishes the planned objectives. It facilitates the reviews performed by supervisors, managers, engagement partners and engagement quality reviewers. Also, it improves effectiveness and efficiency by reducing time-consuming, and sometimes inaccurate, oral explanations of what was done (or not done). According to AU Section 339 Audit Documentation, the auditor must prepare audit documentation in connection with each engagement in sufficient detail to provide a clear understanding of the work performed (including the nature, timing, extent, and results of audit procedures performed), the audit evidence obtained and its source, and the conclusions reached. Therefore, audit documentation (including workpapers) is an essential element of audit quality. Although documentation alone does not guarantee audit quality, the process of preparing sufficient and appropriate documentation contributes to the quality of an audit. As a member of the audit team, it is then expected of you to prepare proper workpapers.

Identify the generally accepted auditing standards violated by E&Y auditors in this case. Briefly explain how each standard was violated.

Throughout the case, Trauger and company violated a few of the auditing standards. First, let us start with the reason why Trauger wanted to change the workpapers. With the major losses of NextCard, Trauger had the responsibility to detect these losses and present it in his report. He should have detected the fraud as an auditor. With him, issuing an unqualified opinion, signifies that he had lapses during sudit and he wanted to alter the papers to coincide with hid prior opinion. What Trauger did was in violation with Auditing Standard No. 15 Audit Evidence. It is clearly stated that the auditor must plan and perform audit procedures to obtain sufficient appropriate audit evidence to provide a reasonable basis for his or her opinion, which Trauger failed to do so. The auditors changing the workpapers were in violation with AU Section 339 Audit Documentation. According to this standard, after the documentation completion date, the auditor must not delete or discard audit documentation before the end of the specified retention period. When the auditor finds it necessary to make an addition (including amendments) to audit documentation after the documentation completion date, the auditor should document the addition in accordance with the standard. This standard is clearly violated by Trauger and company when they altered the dates of the papers and some of its contents. Lasty, the actions done by E&Y auditors were in violation of the Code of Ethics. As an auditor, it is your responsibility to present true and correct information for public use. You should not make alteration or changes just for the benefit of oneself. It should always be remembered to follow the standards to avoid conflicts.

Identify and briefly describe the specific fraud risk factors present during the 2000 NextCard audit. How should these factors have affected the planning and execution of the engagement?

According to AU Section 110, the auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. Therefore, it is important to point out the fraud risk factors in an audit engagement. In the NextCard case, there are various fraud risk factors that can be observed. In the Internal Auditing Standards 240 The Auditor's Responsibility Relating to Fraud in an Audit of Financial Statements Appendix 1, three common examples of fraud risk factors were given, these include incentives/pressure, opportunities, and attitudes/rationalizations. First, the company committed the fraud due to the pressure they are experiencing from external elements. The sudden downfall internet-based industries prompted the company to conceal their already incurring losses. With the downfall, the company had no any means to recover the loss. Also, the flaws of their business model can be corrected anymore. The statement they gave to the public about the $150 million net income added to the pressure the executives are facing. With this, they decided to commit the fraud. Another factor is the opportunities factor. NextCard being one of the largest internet-based companies did not want to lose their position in the market. They wanted to grab the opportunity that people are still availing their services even though the company standing cannot accommodate it already. With this, they decided to commit fraud. Lastly, the attitudes/rationalizations factor. The executive's desire to maintain a high stock price in the market to obtain more customers also led to their desire to commit fraud to attain this. Their thinking that their action is justifiable because they just want what is good for the company, even with the wrong means, is clearly not acceptable. These factors should be considered by the audit team during the engagement. It will not only make the fraud easier to be detected but it can give a valid basis as to why and how they detected such fraudulent activity.

Should auditors evaluate the soundness of a client's business model? Defend your answer.

According to the International Standards of Auditing 210, auditors should only accept a new audit engagement, or continue an existing audit engagement if the 'preconditions for an audit' required by ISA 210 agreeing the terms of audit engagements are present. ISA 210 requires the auditor to: (1) Determine whether the financial reporting framework to be applied in the preparation of the financial statements is appropriate; and (2) Obtain the agreement of management that it acknowledges and understands its responsibilities. If the preconditions for an audit are not present, the auditor should discuss the matter with management, and should not accept the engagement unless required to do so by law or regulation. Also, the American Institute of Certified