Knapp Case Assignment 1.7 Lincoln Savings and Loan Associations

THEOPHILUS ANKAMAH

KNAPP CASE ASSIGNMENT

1.7 LINCOLN SAVINGS AND LOAN ASSOCIATIONS

1. Substance over form is an accounting principle used "to ensure that financial statements give a complete, relevant, and accurate picture of transactions and events". If an entity practices the 'substance over form' concept, then the financial statements will show the overall financial reality of the entity (economic substance), rather than the legal form of transactions (form). In accounting for business transactions and other events, the measurement and reporting is for the economic impact of an event, instead of its legal form. Substance over form is critical for reliable financial reporting. It is particularly relevant in cases of revenue recognition, sale and purchase agreements, etc. The key point of the concept is that a transaction should not be recorded in such a manner as to hide the true intent of the transaction, which would mislead the readers of a company's financial statements.

It’s the auditor’s responsibility to inform the Audit partner and Audit committee of the violation of this principle and also document the violation in detail. Such violation can amount to an audit failure, if the client does not adhere to GAAP. When the “substance over form” is violated, might resulted in material misstatement of financial statement. The auditor have the full responsibility to abandon the engagement or continue the engagement and issue a qualified or adverse opinion. Relating to this scenario, Lincoln’s real estate transaction did not fit the substance over form criteria because transactions did not match economic realities but instead they created huge paper profits.

1. The acceptance of large, high risk audit client for relatively high audit client for relatively high audit fee may threaten an audit firm’s de facto and perceived independence to an extent. If an audit firm is willing to accept high audit fee in order to do an extensive work on high risk audit, then its de-facto and perceived independence cannot be undermined. A high risk audit could bring more challenging issues, which requires more work and effort to be put in engagement. In such cases, the auditors should evaluate whether it worth the risk to keep such client even though the client might be one of major clientele.

On other hand, when the audit firm depends on the high fees as a major component for the engagement, their professional judgement can be compromised. In this case, it might seemed that the auditors are in the engagement just to please their client instead of relating to the risk, the audit might poses. The auditor should be aware of negative financial impact losing such large client, as a result, the auditors might be more lenient with testing and procedures. This issue might noticeable to public and may result in discrediting the audit firm’s independence or potential law suit in the future.

1.  The auditor examination would be definitely be affected, when a client engaged in significant related party transactions, such transactions are generally risky due to the fact that it is easier for the clients to falsify information about economic realities of such transactions. The auditor should consider whether transaction meet the substance over form criteria and whether the transaction have been properly disclosed as mandated in FASB procedures listed in AU section 334,Related Parties “The auditing standards states that the auditor should gain an understanding of the relationship between the parties, perform testing to determine the existence of related parties, understand the purpose of the transaction, examine supporting documents and ensure the transactions have been approved by the Board of Directors and other appropriate parties among various other precautionary procedures.

1. A control environment, also called "Internal control environment", is a term of financial audit, internal audit and Enterprise Risk Management. It means the overall attitude, awareness and actions of directors and management (i.e. "those charged with governance") regarding the internal control system and its importance to the entity. They express it in management style, corporate culture, values, philosophy and operating style, the organizational, and human resources policies and procedures.

Some weakness evident in the Lincoln’s control environment are as follows:

• The 1985 audit outlined that control environment was main concern in the organization
• Management manipulate internal control to maneuver company’s accounting system.
• The top management did not consider managerial and technical competence as requisite guidelines in appointment of Charles Keating III as the president, who did not understand how the corporate environment works.  

1. ACCOUNTING FOR SALES OF REAL ESTATE (ISSUED 10/82)

Summary

This Statement establishes accounting standards for recognizing profit or loss on sales of real estate. It adopts the specialized profit recognition principles in the AICPA Industry Accounting Guides, Accounting for Profit Recognition on Sales of Real Estate and Accounting for Retail Land Sales; and AICPA Statements of Position 75-6, Questions Concerning Profit Recognition on Sales of Real Estate, and 78-4, Application of the Deposit, Installment, and Cost Recovery Methods in Accounting for Sales of Real Estate.