Comprehensive Case A.6 – The Baptist Foundation of Arizona
I. Technical Audit Guidance
To maximize the knowledge acquired by students, this book has been designed to be read
in conjunction with the post-Sarbanes-Oxley technical audit guidance. All of the post-
Sarbanes-Oxley technical guidance is available for free at
http://www.pcaobus.org/Standards/index.aspx. In addition, a summary of the Sarbanes-
Oxley Act of 2002 is also available for free at
http://thecaq.aicpa.org/Resources/Sarbanes+Oxley/Sarbanes-Oxley+–+The+Basics.htm.
II. Recommended Technical Knowledge
The Sarbanes-Oxley Act of 2002
Section 204
Section 301
Section 401
PCAOB Auditing Standard No. 5
Paragraph #2
Paragraph #9
Paragraph #25
Paragraph #28-30
Paragraph #39-41
Paragraph #69
Paragraph #A4 (in Appendix A)
Paragraph #A5 (in Appendix A)
,III. 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. Consider the significant year-end transactions consummated by BFA. Do you believe that the
accounting for these transactions violated the conservatism constraint? Why or why not? Please
be specific when answering the question.
Statement of Financial Accounting Standards (SFAS) # 66 establishes five different
methods of accounting for sales of real estate - different methods are based on the legal
form of the transaction, the type of property sold, the amount of down payment and other
factors.
, Under the full accrual method used by the Foundation Company, the disposition was
recorded as a sale, with any profit resulting from the sale recognized in full and the asset
resulting from the seller’s financing of the transaction reported as a loan. This method
may be used when certain conditions have been met; however, the Foundation
Company’s sale to Dwain Hoover fails to meet several of these conditions, among others,
the following requirements: 1) the buyer's initial investment (down payment) and
continuing investment (periodic payments) are adequate to demonstrate a commitment to
pay for the property; and 2) the receivable is not subject to future subordination.
Unfortunately, based on the evidence, both of these requirements fail to be met, as the
cash down payment from Hoover to The Foundation Companies was funded by a loan to
Hoover by the FMC Holdings, a related party to The Foundation Company Inc. Given
that BFA did not meet the criteria to use the Full Accrual Method, they should not have
recognized the profit from the sale. Since they did recognize the profit, BFA clearly
violated the conservatism constraint.
, 3. Consult Paragraph #2 and Paragraph A5 (in Appendix A) of PCAOB Auditing Standard No. 5.
Do you believe that BFA had established an effective system of internal control over financial
reporting related to its significant year-end transactions? 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 unauthorized acquisition, use, or
disposition of the company's assets that could have a material effect on the financial
statements.”
I. Technical Audit Guidance
To maximize the knowledge acquired by students, this book has been designed to be read
in conjunction with the post-Sarbanes-Oxley technical audit guidance. All of the post-
Sarbanes-Oxley technical guidance is available for free at
http://www.pcaobus.org/Standards/index.aspx. In addition, a summary of the Sarbanes-
Oxley Act of 2002 is also available for free at
http://thecaq.aicpa.org/Resources/Sarbanes+Oxley/Sarbanes-Oxley+–+The+Basics.htm.
II. Recommended Technical Knowledge
The Sarbanes-Oxley Act of 2002
Section 204
Section 301
Section 401
PCAOB Auditing Standard No. 5
Paragraph #2
Paragraph #9
Paragraph #25
Paragraph #28-30
Paragraph #39-41
Paragraph #69
Paragraph #A4 (in Appendix A)
Paragraph #A5 (in Appendix A)
,III. 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. Consider the significant year-end transactions consummated by BFA. Do you believe that the
accounting for these transactions violated the conservatism constraint? Why or why not? Please
be specific when answering the question.
Statement of Financial Accounting Standards (SFAS) # 66 establishes five different
methods of accounting for sales of real estate - different methods are based on the legal
form of the transaction, the type of property sold, the amount of down payment and other
factors.
, Under the full accrual method used by the Foundation Company, the disposition was
recorded as a sale, with any profit resulting from the sale recognized in full and the asset
resulting from the seller’s financing of the transaction reported as a loan. This method
may be used when certain conditions have been met; however, the Foundation
Company’s sale to Dwain Hoover fails to meet several of these conditions, among others,
the following requirements: 1) the buyer's initial investment (down payment) and
continuing investment (periodic payments) are adequate to demonstrate a commitment to
pay for the property; and 2) the receivable is not subject to future subordination.
Unfortunately, based on the evidence, both of these requirements fail to be met, as the
cash down payment from Hoover to The Foundation Companies was funded by a loan to
Hoover by the FMC Holdings, a related party to The Foundation Company Inc. Given
that BFA did not meet the criteria to use the Full Accrual Method, they should not have
recognized the profit from the sale. Since they did recognize the profit, BFA clearly
violated the conservatism constraint.
, 3. Consult Paragraph #2 and Paragraph A5 (in Appendix A) of PCAOB Auditing Standard No. 5.
Do you believe that BFA had established an effective system of internal control over financial
reporting related to its significant year-end transactions? 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 unauthorized acquisition, use, or
disposition of the company's assets that could have a material effect on the financial
statements.”
