TMH case study module1,2,3
Triangle Manufactured Homes Off-Balance-Sheet Transfers of Subprime Loans © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. 3 Module © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. M o d u le 3 130 TMH Case Study – Module 3 Instructions Module 3 Instructions Requirements The preliminary audit risk analysis has identified TMH’s revenue recognition for transfers of installment sales contracts as a high risk audit area. As a reminder, TMH applies sale accounting to these transfers, and the income from sales of installment contracts that is recognized is quite significant for TMH. Without this source of income, the company’s bottom-line likely would be a loss. These transactions also impact THM’s balance sheet. The requirement for the current assignment is that you write a memorandum that addresses important disclosure issues with respect to TMH’s transfers of receivables to banks and other unrelated financial institutions. This memo should provide your analysis of the disclosures TMH proposes to include in its annual report outside the body of the financial statements. The notes to the financial statements are the principal vehicle for these disclosures. Since auditors must also be concerned with statements made by management that appear in Management’s Discussion and Analysis (MD&A), you must also include MD&A in your disclosure analysis. Disclosures pertaining to fair value information are very important. For example, ISA 545, Auditing Fair Value Measurements and Disclosures, states: “The auditor evaluates whether the entity has made appropriate disclosures about fair value information as called for by its financial reporting framework. If an item contains a high degree of measurement uncertainty, the auditor assesses whether the disclosures are sufficient to inform users of such uncertainty” (from paragraph 59), and “If the entity has not appropriately disclosed fair value information required by the applicable financial reporting framework, the auditor evaluates whether the financial statements are materially misstated by the departure from the applicable financial reporting framework” (from paragraph 60). Your memo must advise the audit team on the adequacy of TMH’s proposed disclosures related to the five accounts identified as involving the greatest risks of material misstatements. These five accounts are: • Retained Interest in Sold Receivables • Recourse Liability for Sold Receivables • Inventory • Income from Sales of Installment Contracts • Loss on Recourse Liability These are the principal accounts TMH uses when preparing journal entries for initial transfers of receivables to banks, subsequent journal entries to record the receipt of funds held back by the banks, and when recording provisions and charge-offs related to customer defaults and prepayments. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. M o d u le 3 TMH Case Study – Module 3 Instructions 131 In evaluating TMH’s proposed disclosures, you should assume the financial statement account balances and all numbers included in TMH’s proposed notes to the financial statements and MD&A are in accordance with the applicable financial reporting framework (see the Resources section below for a list of relevant authoritative pronouncements). Thus, your assessment should focus on whether TMH’s proposed disclosures pertaining to these five accounts are complete. You will need to exercise professional judgment when deciding what disclosure elements, taken together, constitute “complete disclosures” under the applicable financial reporting framework. Your integrated understanding of TMH’s business and environment, the nature of transactions affecting these five accounts, and the applicable financial reporting framework largely will determine the quality of the rationale you present in support of your professional judgments. You should also assume that the disclosure requirements pertaining to securitizations (i.e., the transformation of financial assets into securities that are sold to investors) that are stated in FAS 140 are applicable to TMH’s receivables transfers even though, strictly speaking, TMH does not securitize its transferred receivables. You should discuss what you believe are the significant strengths and weaknesses of TMH’s proposed disclosures pertaining to each account. You should also identify any disclosure elements you believe are required under the applicable financial reporting framework but are missing from TMH’s proposed disclosures. Be sure to present supporting rationale for your judgment on what constitutes “complete disclosure” for the five accounts as well as for any disclosure deficiencies you identify. Finally, you should present your assessment (low, moderate or high) of the overall risk of material misstatements that result from deficient or inappropriate disclosures by TMH related to the five accounts. Authoritative Pronouncements You will need to reference several authoritative pronouncements to understand the provisions that govern the adequacy of TMH’s proposed disclosures. These pronouncements are identified in the resources section below, and specific paragraphs in some pronouncements that are most directly applicable to TMH are emphasized. However, you likely will want to read other sections of the pronouncements as well. Note that FAS 114 pertains mainly to receivables or other loans that are still carried on the books of a company, while TMH has transferred almost all of its installment contracts and has derecognized the related receivables. Nevertheless, FAS 114 may provide relevant general guidance on appropriate disclosures to supplement the more specific guidance provided in other pronouncements. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. M o d u le 3 132 TMH Case Study – Module 3 Instructions Resources Provided By Client TMH has provided the preliminary financial statements and related disclosures that management proposes be included in the annual report to shareholders. Applicable Financial Reporting Framework Authoritative pronouncements that you should rely on and reference are listed in the following table. Key paragraphs from each pronouncement have been identified to help focus your analysis, although other information contained in the pronouncements may provide additional guidance that will help with this assignment. These pronouncements can be obtained by going to the Financial Accounting Standards Board web site at http://www.fasb.org/ and following these instructions: Authoritative Pronouncement Key References FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities Paragraphs: 9-12, 17, 68-70, 113, and 342-349 FASB Statement No. 5, Accounting for Contingencies Paragraphs: 8-12, 22, and 23 FASB Statement No. 114, Accounting by Creditors for Impairment of a Loan—An Amendment of FASB Statements No. 5 and 15 Paragraphs: 8, 11-16, and 20 FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss—An Interpretation of FASB Statement No. 5 All FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of the Indebtedness of Others—An Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34 Paragraphs: 2, 3, 8, 9, 12, 13, and A6 1) From the menu bar at the left-hand side of the page select Pronouncements & EITF Abstracts 2) From this page, scroll down to View FASB Pronouncements 3) Under Statements of Financial Accounting Standards, you will be able to access FASB No. 5, FASB No. 114, and FASB No. 140 by selecting the appropriate pronouncement reference (e.g. [126-159] for FASB No. 140) 4) Under FASB Interpretations, you will be able to access FASB Interpretation No. 14 and FASB Interpretation No. 45 by selecting the appropriate pronouncement reference (e.g. [1-25] for FASB Interpretation No. 14) 5) Select [Full Text] to access a PDF document containing the pronouncement. You may download the document to your desktop and/or print it. Other Resources You may access additional resources as well. Additional resources you might find useful include professional accounting and auditing pronouncements, textbooks and other instructional materials, and resources available on the Internet. Triangle Manufactured Homes Off-Balance-Sheet Transfers of Subprime Loans © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. 1 Module M o d u le 1 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. 22 TMH Case Study – Module 1 Instructions Module 1 Instructions Requirements This assignment requires a memorandum in which you present your understanding of TMH’s business and environment, including its key financial characteristics and accounting practices. In the memorandum, you will also provide your assessment of significant inherent risks, at the account level, in the proposed 2007 financial statements, as well as your assessment of going concern risk and fraud risk in view of the understanding you have developed. A single memo is required, and it should include your insights on four interrelated areas: business analysis, accounting analysis, financial analysis, and audit risk assessments.The memo should include separate sections for the first three analyses, and in a fourth section on risk assessments you should discuss clearly and succinctly the linkages between your risk assessments and your integrated business understanding. Analyses from all three perspectives—business, accounting, and financial—are required to provide a proper basis for risk assessments and audit planning, and your memo should reflect this. The most important element of your memo will be your supporting rationale for why you think the inherent risks you