Case 2.

J.B. Hanauer & Co.

Prepared by:

Alexa Rodriguez

for

Professor C.E. Reese

in partial fulfillment of the requirements for

ACC502-- Advanced Auditing

College of Business/Graduate Studies

St. Thomas University

Miami Gardens, Fla

Term SP2/Spring, 2020

March 24, 2020

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 Table of Content

Issues 3

Facts 4

Analysis/Authority 5

Conclusions/Recommendations 8

References 10

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Issues:

1.

What are internal control risks that brokerage firms usually face? What are some of the control risks

from Hanauer’s operations? Were the risks properly investigated by Hanauer’s auditors when planning

the year end tests?

2.

What were Hanauer’s auditor’s objectives in regard to the account confirmation procedures?

Considering the four types of account balances were the objectives reached?

3.

What other audit procedures should Hanauer’s audit team have performed for the accounts where the

confirmation was not obtained?

4.

How do you define a material audit scope limitation? Do you believe that Hanaeur’s management

imposed said limitation on the annual audit?

5.

What issues arise when an audit client follows the audit partner to another accounting firm and has to

make changes because of this?

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Facts:

Brokerage firms differ from other companies in that their financial statements have large

accounts receivables and large short-term payables, which means confirmations for these accounts are

important audit tests. Internal controls for such companies are also vital as a large amount of cash and

securities are exchanged on a daily basis. While Hanauer’s internal controls were questioned by the

SEC, especially for engaging in improper securities transactions, Goldberg stated there were no material

weaknesses in its internal control.

There were four groups of customer accounts that needed confirmations: open accounts with a

credit balance in which Hanauer owed cash to the customer, open accounts with a debit balance in

which the customer owed Hanauer cash, accounts with securities balance, and inactive accounts.

Hanauer requested that Goldberg not send confirmation letters to specific customers. They did perform

additional audit procedures like determining the year end balance of the account was cleared by a

receipt or disbursement to the customer, and every now and then they checked for supporting

documentation.

Hanauer was supposed to be reporting cash transactions that exceeded $10,000 to the IRS;

however, in order to avoid doing so they would enter the amounts in chunks over period of time. Many

of Hanauer’s customers purchased bonds with fictitious names, exchanged large amounts in cash, and

did not have their information verified or even obtained. Hanauer’s sales representatives would also

destroy transaction confirmations between customers, which completely disregarded the company’s

policies. As it turns, the company was involved in multiple money laundering schemes.

Two of Hanauer’s executives were banned from working in the brokerage industry and the

company was fined. SEC also required that they hire a new audit firm and establish better internal

control procedures. Hanauer pled guilty to the criminal charges but insisted that it was just to avoid

litigation costs.

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Analysis:

1.

Typically, internal controls are vital in the brokerage industry because of the large number of

cash and securities that exchange hands daily. Internal controls for a brokerage company should include

segregation of duties, and protecting customer’s identity (Odor, 2014). Without segregation of duties,

one person is in charge of multiple procedures which means they are more likely to be able to cover up

theft or fraud (Odor, 2014). Certain duties that should be split amongst employees include handling

cash, tools, inventory or fixed assets, receiving checks, and writing checks (Odor, 2014). Protecting a

client’s information is important because it contains sensitive information; part of that protection

includes maintaining up to date information (Odor, 2014). In Hanauer’s case, some of the internal

control risks include its adherence to report cash transactions exceeding $10,000, keeping client files up

to date, and retaining source documents. While the audit team discovered internal control deficiencies,

they failed to perform further tests and instead gave an unqualified opinion, which means they neither

investigated adequately nor took their findings into consideration when generating the report.

2.

There were four groups of customer accounts that needed to be reviewed. First, the open

accounts with credit balances, where Hanauer owed money, and the open accounts with debit balances,

where customers owed money; both of which needed confirmation from all customers. The other two

groups, securities and inactive accounts, needed confirmations from a random sample. Unfortunately,

the audit firm did not meet its objectives as it adhered to Hanauer’s request to send confirmations to

certain accounts, when it was supposed to send to all the open accounts.

3.

Goldberg performed additional audit procedures to verify the accounts that had not been

confirmed by determining that the year end balance had been cleared by a receipt or disbursement to

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the customer; he also occasionally checked for source documents. While these procedures are in

compliance with PCAOB standards, the audit firm should have verified more source documents (AU 330

The Confirmation Process). The audit firm then needs to determine the reliability of the alternative

procedures, the nature of any exceptions, and any additional evidence provided (AU 330 The

Confirmation Process). This accounting firm did not do substantial testing in that they did not require

enough source documents as evidence for the accounts they could not confirm.

4.

According to Bragg a scope limitation is a client caused restriction on the auditor which does not

allow the auditor to complete all aspect of the audit procedures (Bragg, 2018). Typically, when a scope

limitation occurs its due to the disappearance of evidence of like in this case, the restriction of

contacting customers for confirmation (Bragg, 2018). In these cases, the audit firm usually has difficult

giving an unqualified opinion (Bragg, 2018). The SEC is correct in saying that Hanauer imposed a

material scope limitation on the audit firm because it requested that they do not send confirmation to

certain customers; this means the auditors were limited in their ability to perform their necessary audit

tests.

5.

In this case it seems like Hanauer had a relationship with Goldberg that questions the ability to

perform an independent audit, since Hanauer continued to follow Goldberg to whichever firm he was

working at the time. They seemed to have a direct business relationship where Hanauer always hired

Goldberg to do the audit instead of sticking with the firm. Anytime there is a questionable relationship,

it should be brought to the attention of the audit committee, so they may make a decision as to how to

proceed (Audit Committees and Auditor Independence, 2017). The audit committee can then further

discuss and investigate the potential impairments that could arise from the lack of independence; the

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audit committee was not informed in this case, meaning that the independence was jeopardized (Audit

Committees and Auditor Independence, 2017).

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Conclusions:

1.

Internal controls are an integral part of any company and should be carefully evaluated in an

audit. In this case, the auditor’s ignored the company’s lack of internal controls, which means they

failed to recognize potential risks and weaknesses in their records. Hanauer’s employees had a huge

lack of respect for the internal control policies, which was apparent when they failed to report cash

transactions over $10,000 and they were unable to maintain accurate customer records. If an auditor

sees internal control deficiencies they should further investigate, perform more tests, notify the audit

committee, and possible even write a qualified opinion stating the issues they found.

2.

When creating an audit plan and identifying the objectives, it is important that the auditors stick

to that. In this case the auditors had wanted to collect confirmations from all open customer accounts.

Instead they were given a list of the accounts they could confirm. If they were restricted in their ability

to look at all accounts, they should have been able to randomly select account, not been told which

accounts they could confirm. If the company was unable to provide them confirmation letters from the

accounts they requested, they should have performed extensive additional procedures like looking at all

the source documents. If those documents were unavailable, then they should have issued a qualified

opinion. Without those confirmations, they were not certain of the company’s account balances and

therefore could not accurately perform their audit.

3.

Again, because not all the accounts could be confirmed, performing extensive additional testing

is necessary in order to verify those account balances. Without sufficient material evidence, the

auditors should issue a qualified opinion.

4.

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 While there will be cases in which material scope limitations occur, like with Hanauer, the audit

firm is at a disadvantage and is severely restricted in being able to accurately perform their audit

procedures. Because of this, issuing a qualified opinion would be highly recommended in order to make

sure that others are aware of this limitation when reviewing the company’s financial statements.

5.

Although it is unfair to limit a company’s ability to choose its auditing firm, an issue of

independence impairment is called into question when a company follows its audit partner to other

firms. It become unclear whether a relationship exists there that could weaken the auditor’s opinion.

Advising the audit committee of this potential relationship and allowing them the ability to decide

whether to use another auditor or not is the best way to avoid any future potential problems.

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References:

Audit Committees and Auditor Independence. (2017, May 12). Retrieved March 24, 2020, from

https://www.sec.gov/info/accountants/audit042707.htm

AU 330 The Confirmation Process. (n.d.). Retrieved March 24, 2020, from

https://pcaobus.org/Standards/Archived/PreReorgStandards/Pages/AU330.aspx

Bragg, S. (2018, June 19). Scope Limitation. Retrieved March 24, 2020, from

https://www.accountingtools.com/articles/2017/5/16/scope-limitation

Odor, S. (2014, January 20). Internal Control in Brokerage Firms. Retrieved March 24, 2020, from

https://shellyodor.wordpress.com/2014/01/20/internal-control-in-brokerage-firms/

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