Consult Paragraph 67 of PCAOB Auditing Standard No. 12. Do you believe that Qwest had established an effective system of internal control over finan- cial reporting related to the presentation and disclosure of its nonrecurring revenue? Why or why not? Solution Yes, I believe this system will be effective as if an auditor understands the company control mechanism, he will be in a better position to analyse the authenticity of the Financial Statements. He will be able to analyse if there any misrepresentation in the statements or frauds with reagards to presentation and disclosure of its nonrecurring revenue. Because normally a company does not report it\'s nonrecurring revenues as it is not a regular income and club it with other incomes. So if an auditior is ware of company\'s control mechanism if will be i a better posiiton to judge the correctiveness of the financial statements..

1. Consult Paragraphs .04–.06 of AU Section 334. Explain why gains recorded on transactions with
related parties would have greater inherent risk of being overstated in the financial statements.
Solution
The auditing standards make clear that auditors need to pay special attention to transactions with
related parties. According to paragraph # 4 of AU Section 334, 'the auditor should be aware of
the possible existence of material related party transactions that could affect the financial
statements.° Moreover, paragraph #5 of AU Section 334 states that in determining the scope of
work to be performed with respect to possible transactions with related parties, the auditor
should obtain an understanding of management responsibilities and the relationship of each
component to the total entity. He should consider controls over management activities, and he
should consider the business purpose served by the various components
of the entity.°
Stated simply, the existence of related parties does cause concern for auditors because of the
possibility that related party transactions are consummated on a basis other than an arm's length
basis. 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. Specifically, that the
parties are dealing from equal bargaining positions, neither party is subject to the other party's
control or influence, and that the transaction is consummated with fairness, integrity and legality.
Given the inherent bias that exists in relationships between related parties, auditors must be
skeptical about the true economic substance in all related party transactions. The simple fact is
that the relationship between the parties could be (and has been) used to help perpetrate
fraudulent transactions (e.g., by enabling the recording of an overstated gain on a sales
transaction).