Knapp Nextcard Case

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Case 5.8 NextCard, Inc. 1. Should auditors evaluate the soundness of a client's business model? Defend your answer. Auditors should not evaluate the soundness of a client's business model. They are not required to have knowledge and expertise to start and maintain a successful business. A business model is usually evaluated by a bank or other financial institution that the company acquires capital from. An auditor is required to uphold integrity and has a responsibility to the stockholders to maintain competence and independence. All of this must be achieved while examining sufficient, pertinent evidence to obtain reasonable assurance as to the material fairness of the client's financial statements. This evidence supports what has happened thus far in the client's business. A business model is a prediction of what is expected for the business by optimistic, biased management, not what has happened in the past. An auditor's role does not include predicting the start-up future of a business, nor to rule out fraud. 2. Identify and briefly describe the specific fraud risk factors present during the 2000 NextCard audit. How should these factors have affected the planning and execution of that engagement? There were many risk factors present during the 2000 NextCard audit: unusually rapid growth and profitability, significant related-party transactions, poor or worsening financial condition when management guarantees debt, and management uses aggressive accounting measures to boost stock price. NextCard, incorporated respectively demonstrated these risks as: extending $1 billion of credit to its customers with an average balance of $2000, executives sold-off large portions of their ownership interests in the company before the financial condition became apparent, in 1999 the company produced a loss of $77.2 billion followed by a $81.9 billion loss in 2000 and

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