Case 6.

7 - The Fund of Funds

Case 6.7 – The Fund of Funds

I. Technical Audit Guidance

To maximize a student’s knowledge acquisition of this material, this book has been designed to
be read in conjunction with the post–Sarbanes-Oxley technical audit guidance. All of the
PCAOB Auditing Standards that are referenced in this book are available for free at
http://pcaobus.org/STANDARDS/Pages/default.aspx. In addition, a summary of the provisions
of the Sarbanes-Oxley Act of 2002 is available for free on the book’s website at
www.mhhe.com/thibodeau4e or at http://www.aicpa.org/Pages/Default.aspx.

II. Case Questions – Answer Key

1. Consider the principles, assumptions and constraints of Generally Accepted Accounting

Principles (GAAP). Define the conservatism constraint and explain why it is important

to users of financial statements.

According to the conservatism constraint, accountants must take care to not overstate assets

or revenues and to not understate liabilitites and expenses. As such, when faced with a choice

between two different solutions, accountants should choose the path that is less likely to

overstate assets or revenues and/or understate liabilites and expenses. The conservatism

constraint is important because users of financial statements can take comfort in knowing that the

management team of a company has been prudent in reporting their financial position and results

of operations.

2. Explain why FOF’s decision to record substantial increases in its natural resource

assets violated the conservatism constraint. Please be specific.

The decision to record substantial increases in natural resources assets was not based on

sufficient and competent evidence about the true value of those assets. Rather, FOF relied on

estimates made by an individual that had a vested interest in increased valuations. Since they did

1
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

choose the path that resulted in overstated assets, FOF clearly violated the conservatism

constraint.

3. Consult Paragragh 2 and Paragraph A5 (in Appendix A) of PCAOB Auditing Standard

No. 5. Do you believe that FOF has established an effective system of internal control

over financial reporting related to the valuation of its natural resource assets? Why or

why not?

According to paragraph #2 of Auditing Standard #5, “effective internal control over financial

reporting provides reasonable assurance regarding the reliability of financial reporting and the

preparation of financial statement for external purposes. If one or more material weaknesses

exist, the company's internal control over financial reporting cannot be considered effective.”

In the Appendix of Auditing Standard #5, paragraph #A5 provides more specifics about the

definition of an internal control system. According to that paragraph, such a system is “a process

designed by, or under the supervision of, the company's principal executive and principal

financial officers, or persons performing similar functions, and effected by the company's board

of directors, management, and other personnel, to provide reasonable assurance regarding the

reliability of financial reporting and the preparation of financial statements for external purposes

in accordance with GAAP and includes those policies and procedures that – (1) Pertain to the

maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions

and dispositions of the assets of the company; (2) Provide reasonable assurance that transactions

are recorded as necessary to permit preparation of financial statements in accordance with

generally accepted accounting principles, and that receipts and expenditures of the company are

being made only in accordance with authorizations of management and directors of the

company; and (3) Provide reasonable assurance regarding prevention or timely detection of

2
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

unauthorized acquisition, use, or disposition of the company's assets that could have a material

effect on the financial statements.”

FOF has not established an effective system of internal control over its financial reporting

related to the valuation of its natural resource assets. At present, the valuation process is

dependent on transactions that are consummated by KRC. Given its role as the fund’s

investment advisor, KRC is not independent and should not be relied upon for this control

activity. Thus, FOF’s internal control system does not provide reasonable assurance that the

transactions are recorded fairly, accurately, and in accordance with GAAP.

4. Consider the valuation assertion related to the natural resources assets. Do you think it

is reasonable for an auditor to rely on a recent sale of a 10 percent interest as evidence

to justify a revaluation of FOF’s remaining 90 percent interest in the natural resource

assets? Why or why not?

No. When assets do not have an active trading market, it is extremely difficult to determine

the asset’s value. In such a situation, an actual sale of a percentage of that asset would typically

go a long way in helping to determine the overall asset’s value. However, in order to rely on

such a sale as audit evidence, an auditor would have to examine whether the sale was actually

consummated on an arm’s length basis. That is, were there any biases that may have entered into

the determination of value? In addition, the sale would have to represent a significant ownership

percentage of the asset, if it were to be used to increase the asset’s value. A sale of a 10%

interest would not be enough to justify a reevaluation of FOF’s remaining 90% interest in a

natural resource asset.

5. Consult Paragraphs 7-8 of PCOAB Auditing Standard No. 15. What other evidence

could an auditor seek to justify the valuation of an asset where there is no active trading

3
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

market? Comment on whether Arthur Andersen’s guidelines for the appreciation of

national resource properties were appropriate under the circumstances. Why or why

not?

Paragraphs 7-8 of PCAOB Auditing Standard No. 15 make clear that the auditor must obtain

evidence that is sufficient and appropriate given the facts and circumstances. The

appropriateness of audit evidence refers to the quality of the evidence gathered for a financial

statement assertion about a financial statement account balance and/or an economic

transaction(s). In this situation, Andersen did not gather appropriate evidence under the

circumstances. Indeed, as described in Andersen’s guidelines for revaluations based upon

unrealized appreciation, which were outlined in the case, the auditor should seek to have

“substantive independent evidence” to justify increases in value. In their memo, Andersen stated

that “Any significant increase in the value of natural resource properties over original cost to

FOF must, for audit purposes, be supported by either:

• an appraisal report rendered by a competent, independent expert; or

• an arms-length sale of a sufficiently large enough portion of a property to

establish a proportionate value for the portion retained”

Of course, the next issue of importance is what actually constitutes “adequate sales data for

valuation purposes”. On this point, Andersen’s memo again provides adequate guidance for

auditors to follow. It states that:

• No unrealized appreciation would be allowed on sales of relatively small percentages

of properties to private investors or others who do not have the necessary expertise to

determine a realistic fair market value. By “relatively small”, we envision

4
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

approximately 50% as being a minimum level in this type of sale to establish

proportionate values for the remaining interests; and

• Appreciation would be allowed if supported by arms-length sales to knowledgeable

outside parties. For example, if King Resources Company sold a 25% interest in the

Arctic permits to Texaco or another major oil company, we believe it would be

appropriate to ascribe proportionate value to the 75% retained.”

6 Consult PCAOB Ethics and Independence Rule 3520. What is auditor independence

and what is its significance to the audit profession? What is the difference between

independence in appearance and independence in fact? Based on the case information,

do you believe that Arthur Andersen violated any principles of auditor independence?

Why or why not?

According to PCAOB Ethics and Independence Rule 3520, “a registered public

accounting firm and its associated persons must be independent of the firm's audit client

throughout the audit and professional engagement period.” Indeed, if the financial statement

auditor is not independent, the financial statements are considered unaudited for all practical

purposes. If the auditor is not independent, the financial statements are considered unaudited for

all practical purposes. In cases where the SEC has found that a CPA firm was not independent, it

has required that the financial statements be re-audited by another firm. A lack of independence

can result in disciplinary action by regulators and/or professional organizations and litigation by

those who relied on the financial statements (e.g., clients and investors). The profession, as a

whole, depends on the value of independence in that the auditor’s opinion on the financial

statements loses its value if the auditor is not considered to be substantially independent from the

management of the firm.

5
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

Article IV of the AICPA’s Professional Code of Conduct requires that “a member in

public practice should be independent in fact and appearance when providing auditing and other

attestation services.” To be independent in fact, an auditor must have integrity, a character of

intellectual honesty and candor; and objectivity, a state of mind of judicial impartiality that

recognizes an obligation of fairness to current and prospective management and owners of a

client, creditors and other stakeholders. To be independent in appearance, the auditor must not

have any obligations or interests in the client, its management, or its owners, that could cause

others to believe the auditor is biased with respect to the client, its management, or its owners. It

is important that even if an auditor maintains independence in fact, that independence in

appearance is also maintained. Without being independent in appearance, the value that the audit

function has to the public is weakened or lost. Given the facts and circumstances of the case,

there are some concerns.

7. Consider that both KRC and FOF, including its NRFA, were audited by Arthur

Andersen. In addition, Arthur Andersen audited King’s personal accounts. Do you

believe these relationships impair the independence of Arthur Andersen? Why or why

not?

While it may be possible for the Arthur Andersen auditors to remain objective and unbiased

(unless the auditor was auditing his/her own work), the interrelationships among the entities

would make it very difficult to do so. Indeed, while the AICPA Code of Professional Conduct

does not specifically preclude auditors from performing audit services for clients that are

interrelated, it is absolutely essential that auditors perform all of their duties in an objective,

unbiased manner.

6
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

In this case, the public may perceive the interdependency of KRC and FOF (since essentially

NRFA’s financial statements rely upon information generated from KRC) as a violation of

independence in appearance. This is particularly true since the partner and manager assigned to

the KRC audit also had the same responsibilities on the NRFA audit. The bottom line is that

students need to consider whether the interrelationship would possibly impair the professional

judgments of the partner and/or manager.

8. Would your answer be any different if the fact pattern changed so that different

partners were assigned to both the KRC audit and the NRFA audit? Please assume that

both audit teams were completely different. Why or why not would your answer be

different?

The answer might be different. As stated previously, the relationships do not explicitly

violate independence in fact (unless the auditor was auditing his/her own work). However, there

is still a question as to whether independence in appearance has been violated. The fact that

there would now be completely different audit teams does help to mitigate the possible

independence in appearance concern. However, the dependency of NRFA’s financial statements

on the information presented by KRC still poses a potential issue of concern. It is certainly

possible that the investing public would still believe that this interdependency might impair

Arthur Andersen’s ability to be objective and unbiased in performing its duties. The bottom line,

again, is that students must consider whether the interdependency would impair the professional

judgments of the auditors.

9. Refer to Sections 201 and 203 of SARBOX. Based on your understanding of the FOF

audit, do you believe these sections were needed? Why or why not? Be specific.

7
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

Section 201 says that it shall be unlawful for a registered public accounting firm to provide

any non-audit service to an issuer contemporaneously with the audit, including: (1) bookkeeping

or other services related to the accounting records or financial statements of the audit client; (2)

financial information systems design and implementation; (3) appraisal or valuation services,

fairness opinions, or contribution-in-kind reports; (4) actuarial services; (5) internal audit

outsourcing services; (6) management functions or human resources; (7) broker or dealer,

investment adviser, or investment banking services; (8) legal services and expert services

unrelated to the audit; (9) any other service that the Board determines, by regulation, is

impermissible. Importantly, the bill allows an accounting firm to “engage in any non-audit

service, including tax services,” that is not listed above, only if the activity is pre-approved by

the audit committee of the issuer. The audit committee is required to disclose to investors in its

periodic filings its decision to pre-approve non-audit services. Section 203 says that the lead

audit or coordinating partner and the reviewing partner must rotate off of the audit every 5 years.

Based on the case information provided, Section 201 would not have had much of an

impact on the Fund of Funds audit. However, Section 203 of the Sarbanes-Oxley Act would

clearly apply to the FOF audit as the lead audit partner and the concurring review audit partner

would have to rotate off of the audit after five years of serving in this capacity. It is likely that

this provision would have indirectly reduced the likelihood that the same partner would have

been auditing both FOF and KRC, depending on the rotation schedule.

Given the importance for auditors to remain objective and unbiased in completing their

professional duties, most would agree that these sections of the law were needed. For example,

Section 201 prevents accounting firms from offering audit services in conjunction with certain

non-audit services, such as human resources. The intent is to make sure that the audit firm is

8
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

only focused on the audit and does not have to worry about whether judgments made on the audit

may impact the ability of the firm to “win” other professional service contracts from the audit

client. In addition, by requiring audit partners to rotate, Section 203 helps to mitigate the

possibility of audit partners becoming too “close” with management at their clients. The law is

therefore designed to ensure that auditors are always unbiased and independent in completing

their audit duties.

10. Consult Paragraphs 7-10 of PCAOB Auditing Standard No. 12. Based on your

understanding of inherent risk assessment, identify three specific factors about IOS

and/or FOF that would be likely to impact your audit procedures if you were

conducting an audit of IOS and/or FOF.

Inherent risk is an essential component of the risk of material misstatement. At the entity and

at the financial statement assertion level, inherent risk refers to the exposure or susceptibility of

an assertion within an entity’s financial statements to a material misstatement, without regard to

the system of internal controls. A detailed understanding of an audit client's business model,

including their products and services is a critical part of an auditor’s inherent risk assessment

process at both the entity level and the financial statement assertion level. Inherent risk

assessment guides the auditor to allocating resources towards testing specific accounts as well as

what planning what substantive tests will be employed during testing.

In order to properly assess inherent risk, an auditor should obtain a detailed understanding of

the audit client’s business and industry. Indeed, according to Paragraph #7 of PCAOB Auditing

Standard No. 12, “The auditor should obtain an understanding of the company and its

environment to understand the events, conditions, and company activities that might reasonably

9
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

be expected to have a significant effect on the risks of material misstatement. Obtaining an

understanding of the company includes understanding:

• The nature of the company;

• Relevant industry, regulatory, and other external factors;

• The company's selection and application of accounting principles, including related

disclosures;

• The company's objectives and strategies and those related business risks that might
reasonably be expected to result in risks of material misstatement; and

• The company's measurement and analysis of its financial performance.”

In addition, according to the professional standards (Paragraph #10 of PCOAB Auditing

Standard No. 12), a detailed understanding of the company also includes “Obtaining an

understanding of the nature of the company includes understanding:

• The company's organizational structure and management personnel;

• The sources of funding of the company's operations and investment activities,
including the company's capital structure, noncapital funding (e.g., subordinated debt
or dependencies on supplier financing), and other debt instruments;
• The company's significant investments, including equity method investments, joint
ventures, and variable interest entities;
• The company's operating characteristics, including its size and complexity;
• The sources of the company's earnings, including the relative profitability of key
products and services; and
• Key supplier and customer relationships.”

Based on the professional standards, if one were auditing IOS and/or FOF, the following

issues might give rise to elevated inherent risk:

10
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

• FOF’s investments were heavily concentrated in American securities and each advisor

was compensated based on the realized and unrealized (paper) appreciation of their

portfolios.

• The industry had become increasingly competitive as new competitors entered the field.

• The entire industry was negatively impacted by a decline in stock market prices.

• The industry was also impacted by significant regulatory changes; a number of national

authorities had put more regulatory controls on fund selling.

• IOS recently violated U.S. law by selling unregistered securities and as part of its

settlement, agreed to a number of restrictions.

• FOF’s recently diversified into assets less affected by the stock market, such as natural

resource assets. This was new for FOF.

• The investments in natural resource interest transactions were portions of interests that

had been previously or were currently owned by another entity (i.e., King group).

FOF is dependent on King Resources, as evidenced by King’s corporate documents and the

lack of resources of FOF in order to make informed decisions. Each sub account within FOF

Prop has an advisor, whose compensation is based on the appreciation of their portfolios. This

could provide incentives for fraud.

11. Consult Paragraphs .04-.06 of AU Section 334. Given that all of FOF Prop’s

investments in natural resources had also been owned (or were currently owned) by a

member of the King group, please comment on why the existence of related parties

11
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

(such as King Resources and FOF) present additional risks to an auditor.

An arm’s length transaction is one that is consummated in the normal course of business

operations in an objective and unbiased manner between unrelated parties. In an arm’s length

transaction, the parties dealing from equal bargaining positions, with neither party subject to the

other’s control or dominant influence; and the transaction is treated with fairness, integrity and

legality.

Given the inherent bias that exists in the relationship between King in his role as advisor to

FOF and the King group, the inherent risk related to these transactions should be elevated.

Although King Resources didn’t own FOF, it had strong connections with the company, and

provided a great deal of advice to the company. There was a clear dependency relationship

established, as it was represented that KRC was the investment advisor to FOF, and there was

never enough information for a clear, well-informed decision. This dependency relationship

suggests that transactions could occur in a manner that was less than an arm’s length basis,

which is an important aspect to be considered in the assessment of the inherent risk.

12. If you were auditing one of the transactions between King Resources and FOF, what

type of evidence would you seek to examine to determine whether the transaction was

consummated on an “arm’s length” basis?

In order to test the transactions in this manner, Andersen would need to obtain a significant

amount of evidence that would support the price that was being charged as well as all the other

significant contractual terms of the transaction. The evidence would have to come from

independent, objective third parties. In addition, the evidence should seek to show that the

transaction was consummated at a price and general transactional terms that are comparable to a

12
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

transaction that occurred in the normal course of business operations in an objective and

unbiased manner between unrelated parties; that is the parties are dealing from equal bargaining

positions, neither party is subject to the other's control or dominant influence, and the transaction

is treated with fairness, integrity and legality.

13. Consult Paragraphs 4-8 of PCAOB Auditing Standard No. 15. Based on your

understanding of audit evidence, did Arthur Andersen rely on competent and sufficient

audit evidence in auditing the valuation assertion related to FOF’s natural resources

assets? Why or why not?

According to paragraph 4 of PCAOB Auditing Standard No. 15, “The auditor must plan and

perform audit procedures to obtain sufficient appropriate audit evidence to provide a reasonable

basis for his or her opinion.” Next, according to paragraph 6 of PCAOB Auditing Standard No.

15, “To be appropriate, audit evidence must be both relevant and reliable in providing support

for the conclusions on which the auditor's opinion is based.” The relevance of audit evidence

specifically relates to whether the evidence gathered actually relates to the financial statement

assertion being tested. That is, will the evidence allow the auditor to reach conclusions related to

that financial statement assertion?

The reliability of the evidence specifically relates to whether the evidence gathered can truly

be relied upon as providing a true indication about the financial statement assertion being tested.

There are a number of factors that should influence an auditor’s conclusions about reliability, the

most important of which is the source (e.g., is it from a third party?) of the audit evidence.

According to paragraph 5 of PCAOB Auditing Standard No. 15, “sufficiency is the measure

of the quantity of audit evidence.” All things being equal, the greater the risk of material

13
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

misstatement related to the financial statement assertion, the more audit evidence will be

gathered by the auditor.

In testing the valuation assertion related to FOF’s natural resource assets, Andersen did not

appear to rely on competent evidence. Although the relevance dimension appears to be met for

the “Summary of 1968 Sales” document, the reliability of this document as evidence to support

the valuation assertion is suspect. Stated simply, since the role of King Resources was “that of a

vendor of properties to the proprietary account” there is no way that Andersen should have relied

on any information supplied by King Resources to support the valuation assertion. Such

information, by its nature, is biased. In addition, the information revealed that King Resources’

profits on sales to FOF were significantly higher than the average profits on all other sales,

which raises serious questions about whether the transactions between FOF and KRC were

actually consummated on an arm's length basis. Finally, given these questions, there does not

appear to be enough evidence gathered to support the valuation assertion. The evidence suggests

that the prices charged by KRC to FOF were excessive, and there is insufficient evidence to the

contrary. As such, Arthur Andersen should have gathered more and better evidence.

14. Consider the series of comparisons prepared by the Denver office of Arthur Andersen

of prices charged by the King group to FOF, King affiliates, and other knowledgeable

industry purchasers. Can you think of any additional evidence that would have

strengthened the “Summary of 1968 Sales”?

In order to test the valuation assertion, Andersen would need to obtain a significant amount

of additional evidence, beyond the “Summary of 1968 Sales”. In this case, relevant comparable

data of similar transactions in the industry would provide additional competent evidence that

14
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

would help to strengthen the Summary of 1968 sales evidence. However, given the significance

of the transaction, an auditor would also need to obtain evidence that would explicitly support

the price that was being charged by KRC to FOF. It is hoped that the evidence would support

the assumption that this transaction was consummated at a price and general transactional terms

that are comparable to a transaction that occurred on an arm's length basis. That is, in the normal

course of business operations in an objective and unbiased manner between unrelated parties and

that neither party is subject to the other's control or dominant influence, and the transaction is

treated with fairness, integrity and legality. The bottom line is that the Summary of 1968 sales

alone will not provide competent and sufficient audit evidence.

15. Consult Paragraphs .09-.10 of AU Section 329. Please explain the primary purpose of

substantive analytical procedures (i.e., the type of procedures that are completed during

the testing stages of an audit). If you completed such procedures on FOF, do you think

you could use KRC’s “Consolidated Sales to Industry,” which illustrated that KRC’s

profits on sales to FOF were 68.2 percent, as compared to 36 percent on all other sales,

to help execute the procedures? How?

When completing substantive analytical procedures, the auditor is using the test to gather

evidence that can be relied upon to support a specific management assertion about the financial

statements. As such, the auditor is relying on the test to help detect a material misstatement

related to that assertion, if it exists. Such analytical procedures are quite different from

analytical procedures completed at the planning stages, which are only designed to direct an

auditor’s attention to areas of higher risk on the audit.

15
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

Given the nature of a substantive analytical procedure, an auditor must take great care in

developing a precise expectation for a particular account balance. The expectation must be

developed independently of an audit client’s management. As a result, it is not likely the KRC’s

“Consolidated Sales to Industry” would be of much use since the report is biased. An auditor

must remember that KRC has significant incentives to demonstrate that the price it had charged

FOF was on an “arm’s length basis”. Thus, the auditors should not rely on this information to

help develop their own independent and unbiased expectation. The auditor must seek to obtain

relevant information from third party sources to complete this test. This is absolutely critical

when you are using the results of substantive analytical procedures to support a financial

statement assertion. There are no shortcuts when attempting to support a financial statement

assertion.

16. Do you believe Andersen’s contention that they had a duty of client confidentiality to

KRC that would, indeed, prohibit the firm from disclosing to FOF any relevant

knowledge it may have had related to KRC’s costs? Why or why not?

According to Rule 301 of the AICPA’s Code of Professional Conduct, a CPA should not

disclose confidential client information without the consent of its client. However, it is

important to point out that Rule 301 does not relieve a CPA from performing his/her other

professional obligations. For example, in Rule 201 of the AICPA’s Code of Professional

Conduct, an auditor is obligated to exercise due professional care in the completion of all

services and obtain sufficient, relevant information to provide a reasonable basis for all

professional judgments.

16
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Case 6.7 - The Fund of Funds

The weight of Rule 301 of the AICPA’s Code of Professional Conduct [client

confidentiality] against Rule 201 [due professional care] is one of particular relevance to Arthur

Andersen and their audit of Fund of Funds (FOF). Arthur Andersen acknowledged that they did

“information gathering” regarding King Resources Company’s (KRC) sales to FOF for the audit

of FOF as of December 31, 1968. Arthur Andersen maintained that they did not disclose the

KRC costs to FOF because of their client confidentiality with KRC. However, in doing so, they

neglected to exercise due professional care for FOF as required by Rule 201 of the AICPA Code

of Professional Conduct. Ultimately, Arthur Andersen was found liable and forced to pay $70

million in civil damages for this case. As such, Rule 301 did not appear to relieve Arthur

Andersen from its due profession care [Rule 201] responsibilities to FOF despite Andersen’s

contention. This is an important point to make to students.

17
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.