Ray, the owner of a small entity, asked Holmes,
CPA, to conduct an audit of the entity’s records. Ray told Holmes that the audit was to be
completed in time to submit audited financial statements to a bank as part of a loan application.
Holmes immediately accepted the engagement and agreed to provide an auditors’ report within three weeks. Ray agreed to pay Holmes a fixed fee plus a bonus if the loan was
Holmes hired two accounting students to conduct the audit and spent several hours telling
them exactly what to do. Holmes told the students not to spend time reviewing the controls
but instead to concentrate on proving the mathematical accuracy of the ledger accounts and
on summarizing the data in the accounting records that support Ray’s financial statements.
The students followed Holmes’ instructions and, after two weeks, gave Holmes the financial
statements, which did not include footnotes. Holmes studied the statements and prepared
an unmodified auditors’ report. The report, however, did not refer to generally accepted
accounting principles or to the fact that Ray had changed to the accounting standard for
Briefly describe each of the principles and indicate how the action(s) of Holmes resulted in
a failure to comply with these principles.