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Case 5.3: The North Face, Inc.

1. I believe auditors should not insist that their clients accepted all proposed audit adjustments
when it is immaterial because as per AU section 312 (05), the auditor is not responsible to obtain
reasonable assurance if the misstatement is not material to the financial statements. With that
being said, the auditor could propose the audit adjustments to their clients but cannot insist
because the inclusion or the exclusion of the misstatement would not have a material effect on
the financial statements.

2. Auditor should take explicit measures to prevent their clients from knowing the materiality
threshold used in the audit. A perfect example was provided in The North Face case, Crawford
was aware of the materiality level for his audit engagement so he knows that his plan would not
be questioned by the Deloitte audit team because it was under the materiality level set for his
audit engagement. If Crawford was unaware of the materiality threshold, he might not have plan
the fraudulent scheme because he would not have been able to provide an appropriate answer for
the gross profit of $800,000.

Auditor and clients do have to have open communication and it is hard for auditors to conceal
this information because first, if the client feels that the auditor is not being open about the
engagement, they might act in the same matter. This would result in a more difficult audit
engagement. Second, based on information requested by auditors, the company would have a
general idea on where the materiality threshold is because they would be requesting for, let say
for example, invoices above a certain dollar amount, this would have revealed the materiality
threshold for the audit engagement.

3. The guidance for revenue recognition is governed by FASB Accounting Standards


Codification topic 605, where it states that revenue should be recognized when realized or
realizable. Realized means that the company has delivered the goods, performed the services or
title has change hands and cash or cash equivalent has already been received. For revenue to be
realizable, the company would have performed all the necessary requirements to receive the
payment in the future.

The principle stated above was violated by the $7.8 million barter transaction because the
company is receiving trade credits. It is unclear as to the value and the usefulness of these trade
credits thus it is hard to measure the monetary value this have to the company. If they are unable
to value what was received, it would be harder for the company to say the amount that can be
realized.
The two consignment case violated ASC 605 because title did not change hands. Inventory on
consignment means that North Face still owns the inventory, title did not change hands and the
company cannot recognized any revenue from this consignment until the goods have been sold to
3rd parties.

4. Audit work papers are a very important part of the audit engagement because it provides
documentation and analysis of all audit findings. AU-C Sec. 230 states that the principal
objective of audit work papers is to provide supporting evidence of the auditors opinion on the
financial statements based on audit findings and documentation during the audit engagement.
The above objective was undermined by Deloitte when they decided to alter North Faces work
papers for 1997 because they are altering and destroying the evidence that supported their 1997
opinion on the audit financial statements. This in turn would bring the question as to the
reliability of the opinion given by Deloitte for the 1997 financial statement.

5. Auditors do not have the responsibility to assess the quality of key decisions made by client
executive because as per AU-C Sec. 240.04, The primary responsibility for the prevention and
detection of fraud rests with both those charged with governance of the entity and management.
As per the guidance, the company is the one responsible for preventing fraud and they are the
ones that would take full responsibility of their key decisions. An independent auditor, regardless
of how familiarized they are with their clients industry, would not be able to have a complete
understanding of the decisions made by the companys management because every company,
even in the same industry, operates differently. Since auditors are unable to understand the
strategic blunders fully, they will be unable to access the quality of the key decisions of key
executives.

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