Ethical Obligations and Decision Making in Accounting, 4/e 1
Case 5-6 Rooster, Hen, Footer, and Burger
Barry Yellen, CPA, is a sole practitioner. The largest audit client in his office is Rooster
Sportswear. Rooster is a privately owned company in Chicken Heights, Idaho, with a 12-person
board of directors.
Barry is in the process of auditing Rooster’s financial statements for the year ended December
31, 2016. He just discovered a related-party transaction that has him worried. For one thing, the
relationship has existed for the past two years, but Barry did not discover it. What’s just as
troubling is that the client hid it from him.
Rooster bought out Hen Sportswear two years ago but still operates it as a separate entity, and
since then has systematically failed to disclose to the private investors related-party transactions
involving the CEO of Rooster, Frank Footer. It seems that Footer is borrowing money from Hen
Questions
1. What are related-party transactions and the obligations of Barry as the auditor of
Rooster Sportswear? Why are related-party transactions a particularly sensitive
area?
Under AU-C Section 550, Related Parties,
Related party relationships and transactions may, in
some circumstances, give rise
to higher risks of material misstatement of the
financial statements than transactions
with unrelated parties. For example, related parties may operate through an
extensive and complex
range of relationships and structures, with a corresponding
increase in the complexity of related party transactions.
Because related parties are not independent of each other, financial reporting
Ethical Obligations and Decision Making in Accounting, 4/e 2
In the context of
related parties, the potential effects of inherent limitations on the
auditor’s
ability to detect material misstatements are greater because of reasons such as
the following:
•
Management may be unaware of the existence of all related party
relationships
and transactions.
Professional skepticism includes being alert to audit evidence that contradicts other audit
evidence obtained or information that brings into question the reliability of documents or
of responses to inquiries obtained from management or directors. It also involves being
alert to conditions that may indicate possible fraud.
Another essential aspect of professional skepticism is a critical assessment of audit
evidence, which comprises both information that supports and corroborates
management’s assertions and any information that contradicts them. A critical
2. What are Barry’s ethical obligations in this case? Include in your discussion the
issues of concern from an audit perspective and why they should be of concern to
Barry in deciding what to do.
Barry’s ethical obligation is to follow the rules in AU-C 550 and other auditing standards
and to use appropriate audit procedures to evaluate the risk of material misstatements in
the financial statements as a result of the related party transactions. He should act with
integrity, make decisions objectively, exercise an appropriate level of skepticism, and
perform services with due care. He cannot let pressure from Frank divert him from these
obligations and the importance of ensuring that the financial statements present fairly
financial position and results of operations including adequate footnote disclosure about
the related party transactions.
3. Assume you are Barry’s best friend and he asks for your advice. What would you
tell Barry and why? Use ethical reasoning in developing the advice.
Ethical Obligations and Decision Making in Accounting, 4/e 4
Barry should be reminded of his ethical and professional obligations and responsibility to
all of the owners/private shareholders/creditors of Rooster. Rights Theory provides that
these stakeholders have a right to receive accurate and reliable financial statements and