Solutions Manuals are available for thousands of the most popular college and high school textbooks in subjects such as Math, Science ( Physics, Chemistry, Biology ), Engineering ( Mechanical, Electrical, Civil ), Business and more. Understanding Auditing Cases homework has never been easier than with Chegg Study.
.Instructor's Solutions Manual (Download only) for Auditing Cases.
Solutions Manual for Auditing and Accounting Cases Investigating Issues of Fraud and Professional Ethics 4th Edition by ThibodeauDownload at: also search:auditing and accounting cases: investigating issues of fraud and professional ethics pdfauditing and accounting cases; 4th edition pdfauditing and accounting cases 4th edition solutionsauditing and accounting cases pdfauditing and accounting cases solutionsthibodeau jay and d freier auditing and accounting cases 4th edition. Solutions manual for auditing and accounting cases investigating issues of fraud and professional ethics 4th edition by thibodeau.1.Case 1.1 - Waste Management: The Expense Recognition PrincipleCopyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Solutions Manual for Auditing and Accounting Cases Investigating Issues ofFraud and Professional Ethics 4th Edition by ThibodeauFull clear download (no formatting errors) at:#1.1 – Waste Management: The Expense Recognition PrincipleI. Technical GuidanceTo maximize a student’s knowledge acquisition of this material, this book has been designed tobe read in conjunction with the post–Sarbanes-Oxleytechnical audit guidance. All of thePCAOB Auditing Standards that are referenced in this book are available for free atIn addition, a summary of the provisionsof the Sarbanes-OxleyAct of 2002 is available for free on the book’s website atwww.mhhe.com/thibodeau4eor at Recommended Technical KnowledgeConceptual FrameworkThe Expense Recognition Principle (sometimes referred to as the Matching Principle)PCAOB Auditing Standard No.
5Paragraph #2PCAOB Auditing Standard No. 15Paragraphs #5-6III. Classroom HintsThis case provides students with an opportunity to appreciate the difficulty that can beassociated with auditing the application of depreciation rules to different types of assets at anaudit client. Since the computation of depreciation expense requires management to estimate thesalvage value and the estimated useful life for each asset depreciated, an auditor is often forcedto evaluate a number of subjective factors when completing his/her procedures. To properly doso, students are able to see that an auditor must first understand the true economic substance of.Case 1.1 - Waste Management: The Expense Recognition PrincipleCopyright © 2014 McGraw-Hill Education. All rights reserved.
No reproduction or distribution without the prior written consent of McGraw-HillEducation.management's estimates for both salvage value and the estimated useful life. After gaining thisunderstanding, the auditor must then determine whether the client has properly calculated andrecorded depreciation expense in accordance with the economically appropriate estimates. Ofcourse, each of these judgments must be made based on sufficient and competent evidence. In.Case 1.1 - Waste Management: The Expense Recognition PrincipleCopyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.addition, the case provides a mechanism to illustrate the importance of identifying relevantfinancial statement assertions and identifying the related control activities that are designed toprevent and/or detect fraud in the post-Sarbanes audit environment.
Finally, the case provides anopportunity for instructors to highlight the responsibility of management and the board ofdirectors for an effective internal control system in the post-Sarbanes audit environment.We believe it is essential for students to carefully read over the recommended technicalknowledge, along with this case reading. The educational psychology literature suggests that theacquisition of technical/factual type knowledge increases dramatically when such knowledge canbe applied in a realistic context.This case assignment will work best if it is used at the time when instructors cover thepurchasing process, the fixed asset process or the audit of depreciation expense. Alternatively,the case can be used when instructors cover the audit evidence topic or when instructors discussthe ways in which a management team can perpetrate a fraud. Indeed, because of thesubjectivity associated with the estimate of an asset’s useful life and salva ge value, the accountcan be used by management as a mechanism to help smooth earnings and/or perpetratefraudulent activity. As a result, we recommend that instructors spend time in class reviewing theimpact that an increase in salvage value and/or an increase in depreciable life can have onreported earnings.
This discussion should help students conceptualize how the application ofdepreciation rules can be used as a mechanism to perpetrate fraudulent activity.Importantly, the goal of the previous discussion is not necessarily to make sure thatstudents are experts in auditing recorded depreciation expense at an audit client with significantinvestments in fixed assets. Rather, we believe that it is important to point out to students thatthey will encounter difficult financial statement accounts to audit in their role as an auditor.Case 1.1 - Waste Management: The Expense Recognition PrincipleCopyright © 2014 McGraw-Hill Education. All rights reserved.
No reproduction or distribution without the prior written consent of McGraw-HillEducation.Therefore, when such an account is encountered, students must take the time to fully understandthe nature and economic substance of the account. The professional judgment that is involved inauditing a difficult financial statement account also provides an opportunity for instructors toremind students of the importance of being unbiased and objective when making their auditjudgments. Indeed, we believe that it is helpful to consistently remind students of theirresponsibility to maintain an attitude of professional skepticism throughout the audit process.Indeed, one of the primary goals of the Sarbanes-Oxley Act of 2002 was to take steps to improvethe independence and objectivity of the audit process (e.g., Section 201). As such, we encourageinstructors to take this opportunity to remind students of their responsibility.This case also provides an opportunity for instructors to highlight the increasedresponsibility that management now has for effective internal controls under the Sarbanes-OxleyAct of 2002 (SARBOX). Under Section 404 of SARBOX, management is responsible forestablishing and maintaining an effective internal control system that is designed to supportreliable financial statement reporting.
In addition, management must undertake a processwhereby they assess the effectiveness of their own internal control system each year. Given thisincreased responsibility, it is amazing for students to see that the management team and Board ofDirectors at Waste Management actually ignored the recommendation made by Arthur Andersento conduct a site by site analysis of their landfills. In the post-Sarbanes environment, this isclearly a process that would have to be in place to insure reliable financial reporting.Finally, this case provides an opportunity to highlight the importance of identifying therelevant financial statement assertions about a significant financial statement account, a criticallyimportant task in the post-Sarbanes environment. The discussion of student responses toquestion #3 provides instructors with an opportunity to discuss this point. In addition, the.Case 1.1 - Waste Management: The Expense Recognition Principle4Copyright © 2014 McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.discussion of student responses to question #3 provides an opportunity for instructors to highlightthe importance of being able to identify an internal control activity that is explicitly designed tosupport reliable financial statement reporting for a particular financial statement assertion. Onceagain, the knowledge required to link an internal control activity to the financial statementassertion is essential in the post-Sarbanes audit environment.
Thus, we encourage instructors totake the time to make this linkage explicit for students in the present context.IV. Assignment Questions & Suggested Answers1. Consider the principles, assumptions and constraints of Generally AcceptedAccounting Principles (GAAP). Define the expense recognition principle (sometimesreferred to as matching principle) and explain why it is important to users of financialstatements.According to the expense recognition principle, costs need to be matched to the revenues thatthey helped to generate. A key point is that expenses should not necessarily be recognized whenthe work is completed or a product is produced.
Rather, the costs should be recognized when thecosts can be “matched” to revenue that has been recorded. If a connection cannot reasonably bemade between a cost and revenue that has been recognized, an accountant still has aresponsibility to try to determine whether there is some type of relationship between the cost andrevenue generated. The absolute goal is to try as hard as possible for an accountant to providethe best measure of the profitability and performance of a company. As a result, accountantsshould attempt to identify as best as possible, how much it cost to generate revenue. This is thebasis of the expense recognition principle.2.
Based on the case information provided, describe specifically how Waste Managementviolated the expense recognition principle. In your description, please identify ajournal entry that may have been used by Waste management to commit the fraud.GAAP requires that depreciation expense be determined by allocating the historical cost ofassets over the useful life of the asset less the salvage value. When the management team at.Case 1.1 - Waste Management: The Expense Recognition Principle5Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Waste Management made changes to the estimated useful life and salvage value of several assets,they effectively reduced the depreciation expense, ultimately resulting in overstated income. Thereduction of depreciation expense in the current year essentially defers depreciation expense to afuture year.
The expense recognition principle requires the depreciation expense of an asset to berecognized over its useful life so that the associated expense is recorded in the year in whichrelated income is earned. The arbitrary changes made to the estimated useful lives and salvagevalues directly violated the matching principle because the depreciation expense recognized infuture years would now be unrelated to the production of income in those related future years.In essence, increases to the useful life of assets have the effect of writing up the value of anasset and reducing expenses. This change can have a material impact on the financial statements.These types of changes, that affect the way a user of financial statements values WasteManagement, must be properly disclosed as required by GAAP under the full disclosureprinciple. This principle requires management to disclose sufficient information to allow the userto make a judgment about the financial position of Waste Management.3. Consult Paragraph 2 of PCAOB Auditing Standard No. Do you believe that WasteManagement had established an effective system of internal control over financialreporting related to the depreciation expense recorded in its financial statements?Why or why not?According to Paragraph #2 of PCAOB Auditing Standard No. 5, “effective internal controlover financial reporting provides reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes.” Waste Managementdid not have an effective system of internal control over financial reporting related to thedepreciation expense recorded in its financial statements.
Stated simply, Waste Management’s.Case 1.1 - Waste Management: The Expense Recognition Principle6Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.internal control system did not provide reasonable assurance that the transactions were recordedfairly, accurately, and in accordance with GAAP.4. Consult Paragraphs 5–6 of PCAOB Auditing Standard No. As an auditor, whattype of evidence would you want to examine to determine whether WasteManagement’s decision to change the useful life and salvage value of its assets wasappropriate under GAAP?A company is allowed to change the useful life and/or the salvage value of its fixed assetsunder GAAP if events or circumstances reveal additional information that indicates that a changeto the useful life and/or salvage value will more accurately depict the current market situation.Stated simply, there should be a legitimate basis to make any changes to these variables. Inaddition, according to the SEC, changes to the variables used in estimating depreciation and theresulting impact to investors should be disclosed in the financial statements to be in accordancewith GAAP.1Paragraphs #5-6 of PCAOB Auditing Standard No.
15 specifically highlight that anauditor must obtain sufficient and appropriate evidence. Sufficiency “is the measure of thequantity of evidence” needed. The quantity of evidence needed will depend upon the risk ofmaterial misstatement and the quality of evidence obtained. The appropriateness of evidencerefers to whether the evidence obtained by the auditor is both relevant and reliable “in providingsupport for the conclusions on which the auditor's opinion is based.” In this situation, an auditorshould examine relevant information about comparable useful lives used in the industry andmonitor the company’s actual experience for similar assets in the past to determine if the firm’sdecision to change the useful life and salvage value of its assets was appropriate under GAAP.Overall, the rationale for changes must be well supported and reasonable. In making this1U.S.
Securities and Exchange Commission. (26 March 2002). “Securities and Exchange Commission vs.
Dean L.Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert A.
Getz, and Bruce D. Tobecksen.”1.1 - Waste Management: The Expense Recognition Principle7Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.determination, interviews with managers and other relevant personnel would be essential, as eachof these estimates are subjective.
Ultimately, the events or circumstances resulting in the needfor the changes would have to be critically evaluated and corroborated with sufficient andcompetent evidence by the auditors. After considering all of the available evidence, if theauditors are still unsure about the decision, they could use an independent third party to evaluatethe changes to the useful life and/or salvage value that are proposed.5.
Visit the PCOAB website (i.e., www.pcaobus.org), search for the “tip and referralcenter” and review the guidelines. Can you report a violation to the PCAOBanonymously? Assuming that the employee knew that the consolidating entries in thefourth quarter recorded by upper management were fraudulent, do you believe thatthe employee had a responsibility to report the behavior to the audit committee?Why or why not?Yes, according to the website, the PCAOB does allow you to report a violation in ananonymous manner. However, according to the website, if you so wish to stay anonymous, thePCAOB asks “that you please contact us again, within 24 hours, so that we may ask anyimportant follow-up questions in response to your tip or referral.”Clearly, there are a number of allowable answers to the second part of this question. Theabsolute key is for a student to try and justify his or her position.
Consider the followingacceptable sample answer from a student:Yes, the employee should have reported the fraudulent behavior to the audit committee.Consistent with the notion that ethical behavior is that which conforms to moral rules andprinciples, the moral action to be taken would have been to report the fraudulent behavior. Infact, when an employee is thinking through his/her ethical decision process, he/she should realizethat in the long run, they may be held responsible for their role in helping to prepare fraudulentfinancial statements. Clearly, the moral action is for the employee to tell the audit committeeabout the fraudulent entries.Case 1.2 - WorldCom: The Revenue Recognition Principle1Copyright © 2014 McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Case #1.2 – WorldCom: The Revenue Recognition PrincipleI. Esbjoern svensson. Technical GuidanceTo maximize a student’s knowledge acquisition of this material, this book has been designed tobe read in conjunction with the post–Sarbanes-Oxleytechnical audit guidance.
All of thePCAOB Auditing Standards that are referenced in this book are available for free atIn addition, a summary of the provisionsof the Sarbanes-OxleyAct of 2002 is available for free on the book’s website atwww.mhhe.com/thibodeau4eor at Recommended Technical KnowledgeConceptual FrameworkThe Revenue Recognition PrinciplePCAOB Auditing Standard No. 5Paragraph #25Paragraph A5 (in Appendix A)PCAOB Auditing Standard No.
12Paragraph #68PCAOB Auditing Standard No. 13Paragraphs #6-7PCAOB Ethics Rule 102Paragraphs #1-2III. Classroom HintsThis case provides students with an opportunity to understand what is meant by companylevel controls and recognize their importance in completing an audit of internal control overfinancial reporting as mandated by Section 404 of SARBOX. By providing details aboutWorldCom's upper management behavior, including their use of “top-side” adjusting journalentries in the period-end financial reporting process, students are able to see the relationship.Case 1.2 - WorldCom: The Revenue Recognition Principle2Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.between an audit client's “tone at the top” and their audit testing strategy. In addition, this caseprovides students with an opportunity to see the potential adverse impact that a CEO can have(i.e., tone at the top) by fostering a culture of “meeting the numbers” at all costs.
Finally, thecase questions provide an opportunity to discuss the role of the internal control system in helpingto prevent or detect material misstatements.We believe it is essential for students to carefully read over the recommended technicalknowledge, along with this case reading. The educational psychology literature suggests that theacquisition of technical/factual type knowledge increases dramatically when such knowledge canbe applied in a realistic context. Thus, we urge instructors to use this case as a mechanism toimpart the relevant post-Sarbanes technical audit knowledge, outlined above.This case assignment will work best if it is scheduled to coincide with the internalcontrols topic or at the beginning of an instructor’s discussion of the audit of internal controlover financial reporting as required by Section 404 of SARBOX. Importantly, in AuditingStandard No. 5, the PCAOB stressed the importance of identifying, understanding and evaluatingthe effectiveness of an audit client’s entity level controls (e.g., tone at the top and period-endfinancial reporting process) as the first step in an audit of internal control over financialreporting.
Because of their pervasiveness throughout the internal control system, the PCAOBbelieves it to be essential to carefully evaluate the entity level controls first in order to completean effective and efficient audit of internal control. Thus, one of the ways that the PCAOBbelieves that the audit can be made more efficient (and effective) is to evaluate company levelcontrols first as a way to provide a foundation towards the understanding of a client’s system ofinternal control.Case 1.2 - WorldCom: The Revenue Recognition Principle3Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Since the concept of company level controls is likely to be new to students, we believethat instructors should allocate enough time to carefully explain this concept in class (seeparagraphs #22-27 of Auditing Standard No. In particular, we recommend that instructorsspend ample time discussing the importance of the control environment and its importance to thesystem of internal control. In addition, we recommend that instructors take the time to explainthe special importance of the period-end financial reporting process to students and the specialrisks presented by “top-side” adjusting journal entries.
The bottom line is that the uppermanagement team at WorldCom helped to perpetrate their fraud using 'top-side' adjustingjournal entries at the end of the reporting process. Since these journal entries are typically notgenerated at the business process level, they can often provide a mechanism for upper managersto circumvent the internal control system and possibly perpetrate a fraud. Thus, auditors mustalways pay close attention to these entries.This case also provides an opportunity to focus on the auditor’s responsibilityto helpprevent and/or detect fraud in the post-Sarbanes audit environment. For example, werecommend that instructors point out that the PCAOB has made it clear that preventing anddetecting fraud MUST be the focus of the audit process (the term “fraud” was mentioned 19times in their Auditing Standard No. Assignment Questions & Suggested Answers1. Consider the principles, assumptions and constraints of Generally AcceptedAccounting Principles (GAAP).
Define the revenue recognition principle and explainwhy it is important to users of financial statements.The revenue recognition principle of GAAP states that revenue must be both earned andrealized before it is recognized and is supported by the FASB Statement of Financial ConceptsNo. For example, in order for revenue to be considered earned, the product must have been.Case 1.2 - WorldCom: The Revenue Recognition Principle4Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.delivered or the services must have been provided to the customer. In addition, the amount ofthe sale needs to be fixed and determinable. Also, the recognition of revenue is dependent on anassumption that the cash will be collected from the customer in a timely manner.2.
Provide one specific example of how WorldCom violated the revenue recognitionprinciple in this situation.WorldCom violated the revenue recognition principle because they recorded revenue entries(with top-side adjusting journal entries) that had no valid economic activity underlying theentries. Rather, the entries were merely a tool to close the gap between the revenue forecast andthe actual revenue earned. The principal tool used to generate the entries was the monthlyrevenue report (“MonRev”) prepared and distributed by the revenue reporting and accountinggroup. The MonRev included dozens of spreadsheets detailing actual revenue data from all of thecompany’s channels and segments.WorldCom maintained a fairly automated process for closing and consolidating operationalrevenue numbers on the MonRev. By the tenth day after the end of the month, the revenueaccounting group prepared a draft, referred to as the “Preliminary” MonRev.
In general, thispreliminary report was compared to the targeted revenue numbers and the difference was used asthe basis for a top-side adjusting journal entry to close the gap. In essence, by booking revenueentries with no underlying business activity, WorldCom violated the revenue recognitionprinciple.3. Consult Paragraph A5 (in Appendix A) of PCAOB Auditing Standard No. 5 andParagraph 68 of PCAOB Auditing Standard No. Do you believe that WorldComhad established an effective system of internal control over financial reportingrelated to the revenue recorded in its financial statements?According to Paragraph A5 (in Appendix A) of PCAOB Auditing Standard No.
5, theinternal control system is a process that is ultimately designed to “provide reasonable assurance.Case 1.2 - WorldCom: The Revenue Recognition Principle5Copyright © 2014 McGraw-Hill Education. All rights reserved.
No reproduction or distribution without the prior written consent of McGraw-HillEducation.regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with GAAP.” The professional standards also place specialemphasis on the risk of fraud related to revenue recognition in Paragraph #68 of PCAOBAuditing Standard No. As a result, an auditor has to take great care to insure that the controlsaround the recognition of revenue are designed and operate effectively.WorldCom did not have an effective system of internal control over financial reportingrelated to the recording of revenue in its financial statements. Rather, the system allowed top-side adjusting journal entries to be recorded without any underlying business activity. Byallowing these invalid entries to occur, WorldCom’s system of internal control was not effective.Overall, a key premise of this book is to help simplify the relationship between a company’sinternal control system and the financial statement account balances.
Section 404 of SARBOXmade clear that this relationship is paramount.This case provides an opportunity to highlight the importance of being able to identify aninternal control activity that is explicitly designed to support reliable financial statementreporting for a particular financial statement assertion. For example, one relevant financialstatement assertion related to the revenue account for this activity is occurrence. It is relevantbecause there is some question as to whether there was real economic activity to support therevenue transactions that were recorded in the financial statements, especially those transactionsrecorded at the corporate level. It is important to highlight that this economic activity wasbooked at the corporate level as top-side adjustments, detached from the actual economic activityat the business process level. And, there was no control system in place to prevent such an entryfrom occurring.Case 1.2 - WorldCom: The Revenue Recognition Principle6Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.4.
Consult Paragraph 25 of PCAOB Auditing Standard No. Define what is meantby control environment. Next explain why the control environment is so importantto effective internal control over financial reporting at an audit client likeWorldCom.The control environment sets the tone for the organization and provides a platform or afoundation for the entire internal control system. The control environment is influenced heavilyby a company’s management team and is therefore often referred to as “the tone at the top”.With respect to the control environment, the absolute key for management is to try and impactthe attitudes towards internal controls throughout the organization by setting the proper examplefor the organization to follow. Paragraph #25 of Auditing Standard No. 5 outlines the auditor’sresponsibilities to understand the control environment. Indeed, “because of its importance toeffective internal control over financial reporting, the auditor must evaluate the controlenvironment at the company.”Stated simply, the control environment has a “pervasive” effect on the reliability of financialreporting at WorldCom and all audit clients because it impacts ALL other components of anorganization’s internal control system.
The lack of an appropriate control environment sends amessage to all employees that management does not believe internal controls are important forefficiency and effectiveness of financial reporting.While a complete evaluation of the control environment at WorldCom is not possible withonly the case information, students should at least point out that Ebbers’ compensationphilosophy (with its focus on double digit revenue growth) should raise serious concerns abouttheir control environment. In fact, the WorldCom case provides a terrific context to illustratethat an organization’s compensation policy can also be used as a mechanism to foster anexcellent control environment. However, it does not appear that WorldCom has taken advantage.Case 1.2 - WorldCom: The Revenue Recognition Principleof this opportunity. Overall, by the end of class discussion, it should be clear that a propercontrol environment provides a foundation for the entire internal control system.5. Consult Paragraphs 6–7 of PCAOB Auditing Standard No. If you were auditingWorldCom, what type of documentary evidence would you require to evaluate thevalidity and propriety of a top-side journal entry made to the revenue account?Top-side journal entries are adjustments that are typically made by top management at thecorporate level.
According to the AICPA, these adjustments are typically made at the end of thefinancial reporting period and are not always posted to the general ledger.1Often, these entriesare not directly associated with actual economic activity as they do not emanate from thebusiness operations of a division or a business unit. These types of entries have been usedfrequently in the past by upper managers as a manner in which to perpetrate fraud. As a result,they often result in a fraud risk that must be addressed in a skeptical manner by auditors. Indeed,Paragraph #7 of PCAOB Auditing Standard No. 13 explicitlystates that the “auditor's responsesto the assessed risks of material misstatement, particularly fraud risks, should involve theapplication of professional skepticism in gathering and evaluating audit evidence.”In evaluating the propriety of a top-side journal entry, an auditor would want to firstinterview management and review any set policies and procedures related to top-side journalentries. The auditors would also want to vouch the supporting documentation for economicsubstance and ensure that it has been properly entered in the financial statements. If, forinstance, the top-side entries resulted in decreased depreciation due to increasing the salvagevalue of the trucks, the auditor may want to obtain written confirmation from an appraiser, orother evidence from a third party.
Students may discuss various examples and types of evidencethat would be required to evaluate the propriety of a “top-side” journal entry. Students’ answers1AICPA. “Journal Entries and Other Adjustments.” The CPA Letter/Public Accounting Firms.
June 2003.Case 1.2 - WorldCom: The Revenue Recognition Principleshould support their examples as in the example above. The absolute key for the auditor is toevaluate the economic substance of the entry with sufficient and competent evidence.6. Consult Paragraphs 1–2 of Ethics Rule 102 (ET 102). Next, consider the roles of RonLomenzo and Lisa Taranto. Assume that these employees knew that the entriesbeing proposed by Scott Sullivan were fraudulent; do you believe that Lomenzo andTaranto should have recorded the journal entries as directed by Sullivan? Why orwhy not?Ethics Rule 102 makes clear that a CPA must not “knowingly misrepresent facts” whencompleting his/her work. Indeed, according to Paragraph #1 of Ethics Rule 102 (ET 102), “inthe performance of any professional service, a member shall maintain objectivity and integrity,shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate hisor her judgment to others.” This rule extends to situations where the CPA knows another personis making the false journal entries.
Consider that Paragraph #2 states that a “member shall beconsidered to have knowingly misrepresented facts” when he/she “makes, or permits or directsanother to make, materially false and misleading entries in an entity’s financial statements orrecords.”As a result, for CPAs, the standards are entirely clear. If Lomenzo and Taranto knew that theentries were fraudulent, the ethical decision would be to not record the entries. While the easierdecision may be to follow Sullivan’s orders, it is clearly not the right decision.
- Author: admin
- Category: Category
Solutions Manuals are available for thousands of the most popular college and high school textbooks in subjects such as Math, Science ( Physics, Chemistry, Biology ), Engineering ( Mechanical, Electrical, Civil ), Business and more. Understanding Auditing Cases homework has never been easier than with Chegg Study.
.Instructor's Solutions Manual (Download only) for Auditing Cases.
Solutions Manual for Auditing and Accounting Cases Investigating Issues of Fraud and Professional Ethics 4th Edition by ThibodeauDownload at: also search:auditing and accounting cases: investigating issues of fraud and professional ethics pdfauditing and accounting cases; 4th edition pdfauditing and accounting cases 4th edition solutionsauditing and accounting cases pdfauditing and accounting cases solutionsthibodeau jay and d freier auditing and accounting cases 4th edition. Solutions manual for auditing and accounting cases investigating issues of fraud and professional ethics 4th edition by thibodeau.1.Case 1.1 - Waste Management: The Expense Recognition PrincipleCopyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Solutions Manual for Auditing and Accounting Cases Investigating Issues ofFraud and Professional Ethics 4th Edition by ThibodeauFull clear download (no formatting errors) at:#1.1 – Waste Management: The Expense Recognition PrincipleI. Technical GuidanceTo maximize a student’s knowledge acquisition of this material, this book has been designed tobe read in conjunction with the post–Sarbanes-Oxleytechnical audit guidance. All of thePCAOB Auditing Standards that are referenced in this book are available for free atIn addition, a summary of the provisionsof the Sarbanes-OxleyAct of 2002 is available for free on the book’s website atwww.mhhe.com/thibodeau4eor at Recommended Technical KnowledgeConceptual FrameworkThe Expense Recognition Principle (sometimes referred to as the Matching Principle)PCAOB Auditing Standard No.
5Paragraph #2PCAOB Auditing Standard No. 15Paragraphs #5-6III. Classroom HintsThis case provides students with an opportunity to appreciate the difficulty that can beassociated with auditing the application of depreciation rules to different types of assets at anaudit client. Since the computation of depreciation expense requires management to estimate thesalvage value and the estimated useful life for each asset depreciated, an auditor is often forcedto evaluate a number of subjective factors when completing his/her procedures. To properly doso, students are able to see that an auditor must first understand the true economic substance of.Case 1.1 - Waste Management: The Expense Recognition PrincipleCopyright © 2014 McGraw-Hill Education. All rights reserved.
No reproduction or distribution without the prior written consent of McGraw-HillEducation.management's estimates for both salvage value and the estimated useful life. After gaining thisunderstanding, the auditor must then determine whether the client has properly calculated andrecorded depreciation expense in accordance with the economically appropriate estimates. Ofcourse, each of these judgments must be made based on sufficient and competent evidence. In.Case 1.1 - Waste Management: The Expense Recognition PrincipleCopyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.addition, the case provides a mechanism to illustrate the importance of identifying relevantfinancial statement assertions and identifying the related control activities that are designed toprevent and/or detect fraud in the post-Sarbanes audit environment.
Finally, the case provides anopportunity for instructors to highlight the responsibility of management and the board ofdirectors for an effective internal control system in the post-Sarbanes audit environment.We believe it is essential for students to carefully read over the recommended technicalknowledge, along with this case reading. The educational psychology literature suggests that theacquisition of technical/factual type knowledge increases dramatically when such knowledge canbe applied in a realistic context.This case assignment will work best if it is used at the time when instructors cover thepurchasing process, the fixed asset process or the audit of depreciation expense. Alternatively,the case can be used when instructors cover the audit evidence topic or when instructors discussthe ways in which a management team can perpetrate a fraud. Indeed, because of thesubjectivity associated with the estimate of an asset’s useful life and salva ge value, the accountcan be used by management as a mechanism to help smooth earnings and/or perpetratefraudulent activity. As a result, we recommend that instructors spend time in class reviewing theimpact that an increase in salvage value and/or an increase in depreciable life can have onreported earnings.
This discussion should help students conceptualize how the application ofdepreciation rules can be used as a mechanism to perpetrate fraudulent activity.Importantly, the goal of the previous discussion is not necessarily to make sure thatstudents are experts in auditing recorded depreciation expense at an audit client with significantinvestments in fixed assets. Rather, we believe that it is important to point out to students thatthey will encounter difficult financial statement accounts to audit in their role as an auditor.Case 1.1 - Waste Management: The Expense Recognition PrincipleCopyright © 2014 McGraw-Hill Education. All rights reserved.
No reproduction or distribution without the prior written consent of McGraw-HillEducation.Therefore, when such an account is encountered, students must take the time to fully understandthe nature and economic substance of the account. The professional judgment that is involved inauditing a difficult financial statement account also provides an opportunity for instructors toremind students of the importance of being unbiased and objective when making their auditjudgments. Indeed, we believe that it is helpful to consistently remind students of theirresponsibility to maintain an attitude of professional skepticism throughout the audit process.Indeed, one of the primary goals of the Sarbanes-Oxley Act of 2002 was to take steps to improvethe independence and objectivity of the audit process (e.g., Section 201). As such, we encourageinstructors to take this opportunity to remind students of their responsibility.This case also provides an opportunity for instructors to highlight the increasedresponsibility that management now has for effective internal controls under the Sarbanes-OxleyAct of 2002 (SARBOX). Under Section 404 of SARBOX, management is responsible forestablishing and maintaining an effective internal control system that is designed to supportreliable financial statement reporting.
In addition, management must undertake a processwhereby they assess the effectiveness of their own internal control system each year. Given thisincreased responsibility, it is amazing for students to see that the management team and Board ofDirectors at Waste Management actually ignored the recommendation made by Arthur Andersento conduct a site by site analysis of their landfills. In the post-Sarbanes environment, this isclearly a process that would have to be in place to insure reliable financial reporting.Finally, this case provides an opportunity to highlight the importance of identifying therelevant financial statement assertions about a significant financial statement account, a criticallyimportant task in the post-Sarbanes environment. The discussion of student responses toquestion #3 provides instructors with an opportunity to discuss this point. In addition, the.Case 1.1 - Waste Management: The Expense Recognition Principle4Copyright © 2014 McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.discussion of student responses to question #3 provides an opportunity for instructors to highlightthe importance of being able to identify an internal control activity that is explicitly designed tosupport reliable financial statement reporting for a particular financial statement assertion. Onceagain, the knowledge required to link an internal control activity to the financial statementassertion is essential in the post-Sarbanes audit environment.
Thus, we encourage instructors totake the time to make this linkage explicit for students in the present context.IV. Assignment Questions & Suggested Answers1. Consider the principles, assumptions and constraints of Generally AcceptedAccounting Principles (GAAP). Define the expense recognition principle (sometimesreferred to as matching principle) and explain why it is important to users of financialstatements.According to the expense recognition principle, costs need to be matched to the revenues thatthey helped to generate. A key point is that expenses should not necessarily be recognized whenthe work is completed or a product is produced.
Rather, the costs should be recognized when thecosts can be “matched” to revenue that has been recorded. If a connection cannot reasonably bemade between a cost and revenue that has been recognized, an accountant still has aresponsibility to try to determine whether there is some type of relationship between the cost andrevenue generated. The absolute goal is to try as hard as possible for an accountant to providethe best measure of the profitability and performance of a company. As a result, accountantsshould attempt to identify as best as possible, how much it cost to generate revenue. This is thebasis of the expense recognition principle.2.
Based on the case information provided, describe specifically how Waste Managementviolated the expense recognition principle. In your description, please identify ajournal entry that may have been used by Waste management to commit the fraud.GAAP requires that depreciation expense be determined by allocating the historical cost ofassets over the useful life of the asset less the salvage value. When the management team at.Case 1.1 - Waste Management: The Expense Recognition Principle5Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Waste Management made changes to the estimated useful life and salvage value of several assets,they effectively reduced the depreciation expense, ultimately resulting in overstated income. Thereduction of depreciation expense in the current year essentially defers depreciation expense to afuture year.
The expense recognition principle requires the depreciation expense of an asset to berecognized over its useful life so that the associated expense is recorded in the year in whichrelated income is earned. The arbitrary changes made to the estimated useful lives and salvagevalues directly violated the matching principle because the depreciation expense recognized infuture years would now be unrelated to the production of income in those related future years.In essence, increases to the useful life of assets have the effect of writing up the value of anasset and reducing expenses. This change can have a material impact on the financial statements.These types of changes, that affect the way a user of financial statements values WasteManagement, must be properly disclosed as required by GAAP under the full disclosureprinciple. This principle requires management to disclose sufficient information to allow the userto make a judgment about the financial position of Waste Management.3. Consult Paragraph 2 of PCAOB Auditing Standard No. Do you believe that WasteManagement had established an effective system of internal control over financialreporting related to the depreciation expense recorded in its financial statements?Why or why not?According to Paragraph #2 of PCAOB Auditing Standard No. 5, “effective internal controlover financial reporting provides reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes.” Waste Managementdid not have an effective system of internal control over financial reporting related to thedepreciation expense recorded in its financial statements.
Stated simply, Waste Management’s.Case 1.1 - Waste Management: The Expense Recognition Principle6Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.internal control system did not provide reasonable assurance that the transactions were recordedfairly, accurately, and in accordance with GAAP.4. Consult Paragraphs 5–6 of PCAOB Auditing Standard No. As an auditor, whattype of evidence would you want to examine to determine whether WasteManagement’s decision to change the useful life and salvage value of its assets wasappropriate under GAAP?A company is allowed to change the useful life and/or the salvage value of its fixed assetsunder GAAP if events or circumstances reveal additional information that indicates that a changeto the useful life and/or salvage value will more accurately depict the current market situation.Stated simply, there should be a legitimate basis to make any changes to these variables. Inaddition, according to the SEC, changes to the variables used in estimating depreciation and theresulting impact to investors should be disclosed in the financial statements to be in accordancewith GAAP.1Paragraphs #5-6 of PCAOB Auditing Standard No.
15 specifically highlight that anauditor must obtain sufficient and appropriate evidence. Sufficiency “is the measure of thequantity of evidence” needed. The quantity of evidence needed will depend upon the risk ofmaterial misstatement and the quality of evidence obtained. The appropriateness of evidencerefers to whether the evidence obtained by the auditor is both relevant and reliable “in providingsupport for the conclusions on which the auditor's opinion is based.” In this situation, an auditorshould examine relevant information about comparable useful lives used in the industry andmonitor the company’s actual experience for similar assets in the past to determine if the firm’sdecision to change the useful life and salvage value of its assets was appropriate under GAAP.Overall, the rationale for changes must be well supported and reasonable. In making this1U.S.
Securities and Exchange Commission. (26 March 2002). “Securities and Exchange Commission vs.
Dean L.Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert A.
Getz, and Bruce D. Tobecksen.”1.1 - Waste Management: The Expense Recognition Principle7Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.determination, interviews with managers and other relevant personnel would be essential, as eachof these estimates are subjective.
Ultimately, the events or circumstances resulting in the needfor the changes would have to be critically evaluated and corroborated with sufficient andcompetent evidence by the auditors. After considering all of the available evidence, if theauditors are still unsure about the decision, they could use an independent third party to evaluatethe changes to the useful life and/or salvage value that are proposed.5.
Visit the PCOAB website (i.e., www.pcaobus.org), search for the “tip and referralcenter” and review the guidelines. Can you report a violation to the PCAOBanonymously? Assuming that the employee knew that the consolidating entries in thefourth quarter recorded by upper management were fraudulent, do you believe thatthe employee had a responsibility to report the behavior to the audit committee?Why or why not?Yes, according to the website, the PCAOB does allow you to report a violation in ananonymous manner. However, according to the website, if you so wish to stay anonymous, thePCAOB asks “that you please contact us again, within 24 hours, so that we may ask anyimportant follow-up questions in response to your tip or referral.”Clearly, there are a number of allowable answers to the second part of this question. Theabsolute key is for a student to try and justify his or her position.
Consider the followingacceptable sample answer from a student:Yes, the employee should have reported the fraudulent behavior to the audit committee.Consistent with the notion that ethical behavior is that which conforms to moral rules andprinciples, the moral action to be taken would have been to report the fraudulent behavior. Infact, when an employee is thinking through his/her ethical decision process, he/she should realizethat in the long run, they may be held responsible for their role in helping to prepare fraudulentfinancial statements. Clearly, the moral action is for the employee to tell the audit committeeabout the fraudulent entries.Case 1.2 - WorldCom: The Revenue Recognition Principle1Copyright © 2014 McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Case #1.2 – WorldCom: The Revenue Recognition PrincipleI. Esbjoern svensson. Technical GuidanceTo maximize a student’s knowledge acquisition of this material, this book has been designed tobe read in conjunction with the post–Sarbanes-Oxleytechnical audit guidance.
All of thePCAOB Auditing Standards that are referenced in this book are available for free atIn addition, a summary of the provisionsof the Sarbanes-OxleyAct of 2002 is available for free on the book’s website atwww.mhhe.com/thibodeau4eor at Recommended Technical KnowledgeConceptual FrameworkThe Revenue Recognition PrinciplePCAOB Auditing Standard No. 5Paragraph #25Paragraph A5 (in Appendix A)PCAOB Auditing Standard No.
12Paragraph #68PCAOB Auditing Standard No. 13Paragraphs #6-7PCAOB Ethics Rule 102Paragraphs #1-2III. Classroom HintsThis case provides students with an opportunity to understand what is meant by companylevel controls and recognize their importance in completing an audit of internal control overfinancial reporting as mandated by Section 404 of SARBOX. By providing details aboutWorldCom's upper management behavior, including their use of “top-side” adjusting journalentries in the period-end financial reporting process, students are able to see the relationship.Case 1.2 - WorldCom: The Revenue Recognition Principle2Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.between an audit client's “tone at the top” and their audit testing strategy. In addition, this caseprovides students with an opportunity to see the potential adverse impact that a CEO can have(i.e., tone at the top) by fostering a culture of “meeting the numbers” at all costs.
Finally, thecase questions provide an opportunity to discuss the role of the internal control system in helpingto prevent or detect material misstatements.We believe it is essential for students to carefully read over the recommended technicalknowledge, along with this case reading. The educational psychology literature suggests that theacquisition of technical/factual type knowledge increases dramatically when such knowledge canbe applied in a realistic context. Thus, we urge instructors to use this case as a mechanism toimpart the relevant post-Sarbanes technical audit knowledge, outlined above.This case assignment will work best if it is scheduled to coincide with the internalcontrols topic or at the beginning of an instructor’s discussion of the audit of internal controlover financial reporting as required by Section 404 of SARBOX. Importantly, in AuditingStandard No. 5, the PCAOB stressed the importance of identifying, understanding and evaluatingthe effectiveness of an audit client’s entity level controls (e.g., tone at the top and period-endfinancial reporting process) as the first step in an audit of internal control over financialreporting.
Because of their pervasiveness throughout the internal control system, the PCAOBbelieves it to be essential to carefully evaluate the entity level controls first in order to completean effective and efficient audit of internal control. Thus, one of the ways that the PCAOBbelieves that the audit can be made more efficient (and effective) is to evaluate company levelcontrols first as a way to provide a foundation towards the understanding of a client’s system ofinternal control.Case 1.2 - WorldCom: The Revenue Recognition Principle3Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.Since the concept of company level controls is likely to be new to students, we believethat instructors should allocate enough time to carefully explain this concept in class (seeparagraphs #22-27 of Auditing Standard No. In particular, we recommend that instructorsspend ample time discussing the importance of the control environment and its importance to thesystem of internal control. In addition, we recommend that instructors take the time to explainthe special importance of the period-end financial reporting process to students and the specialrisks presented by “top-side” adjusting journal entries.
The bottom line is that the uppermanagement team at WorldCom helped to perpetrate their fraud using 'top-side' adjustingjournal entries at the end of the reporting process. Since these journal entries are typically notgenerated at the business process level, they can often provide a mechanism for upper managersto circumvent the internal control system and possibly perpetrate a fraud. Thus, auditors mustalways pay close attention to these entries.This case also provides an opportunity to focus on the auditor’s responsibilityto helpprevent and/or detect fraud in the post-Sarbanes audit environment. For example, werecommend that instructors point out that the PCAOB has made it clear that preventing anddetecting fraud MUST be the focus of the audit process (the term “fraud” was mentioned 19times in their Auditing Standard No. Assignment Questions & Suggested Answers1. Consider the principles, assumptions and constraints of Generally AcceptedAccounting Principles (GAAP).
Define the revenue recognition principle and explainwhy it is important to users of financial statements.The revenue recognition principle of GAAP states that revenue must be both earned andrealized before it is recognized and is supported by the FASB Statement of Financial ConceptsNo. For example, in order for revenue to be considered earned, the product must have been.Case 1.2 - WorldCom: The Revenue Recognition Principle4Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.delivered or the services must have been provided to the customer. In addition, the amount ofthe sale needs to be fixed and determinable. Also, the recognition of revenue is dependent on anassumption that the cash will be collected from the customer in a timely manner.2.
Provide one specific example of how WorldCom violated the revenue recognitionprinciple in this situation.WorldCom violated the revenue recognition principle because they recorded revenue entries(with top-side adjusting journal entries) that had no valid economic activity underlying theentries. Rather, the entries were merely a tool to close the gap between the revenue forecast andthe actual revenue earned. The principal tool used to generate the entries was the monthlyrevenue report (“MonRev”) prepared and distributed by the revenue reporting and accountinggroup. The MonRev included dozens of spreadsheets detailing actual revenue data from all of thecompany’s channels and segments.WorldCom maintained a fairly automated process for closing and consolidating operationalrevenue numbers on the MonRev. By the tenth day after the end of the month, the revenueaccounting group prepared a draft, referred to as the “Preliminary” MonRev.
In general, thispreliminary report was compared to the targeted revenue numbers and the difference was used asthe basis for a top-side adjusting journal entry to close the gap. In essence, by booking revenueentries with no underlying business activity, WorldCom violated the revenue recognitionprinciple.3. Consult Paragraph A5 (in Appendix A) of PCAOB Auditing Standard No. 5 andParagraph 68 of PCAOB Auditing Standard No. Do you believe that WorldComhad established an effective system of internal control over financial reportingrelated to the revenue recorded in its financial statements?According to Paragraph A5 (in Appendix A) of PCAOB Auditing Standard No.
5, theinternal control system is a process that is ultimately designed to “provide reasonable assurance.Case 1.2 - WorldCom: The Revenue Recognition Principle5Copyright © 2014 McGraw-Hill Education. All rights reserved.
No reproduction or distribution without the prior written consent of McGraw-HillEducation.regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with GAAP.” The professional standards also place specialemphasis on the risk of fraud related to revenue recognition in Paragraph #68 of PCAOBAuditing Standard No. As a result, an auditor has to take great care to insure that the controlsaround the recognition of revenue are designed and operate effectively.WorldCom did not have an effective system of internal control over financial reportingrelated to the recording of revenue in its financial statements. Rather, the system allowed top-side adjusting journal entries to be recorded without any underlying business activity. Byallowing these invalid entries to occur, WorldCom’s system of internal control was not effective.Overall, a key premise of this book is to help simplify the relationship between a company’sinternal control system and the financial statement account balances.
Section 404 of SARBOXmade clear that this relationship is paramount.This case provides an opportunity to highlight the importance of being able to identify aninternal control activity that is explicitly designed to support reliable financial statementreporting for a particular financial statement assertion. For example, one relevant financialstatement assertion related to the revenue account for this activity is occurrence. It is relevantbecause there is some question as to whether there was real economic activity to support therevenue transactions that were recorded in the financial statements, especially those transactionsrecorded at the corporate level. It is important to highlight that this economic activity wasbooked at the corporate level as top-side adjustments, detached from the actual economic activityat the business process level. And, there was no control system in place to prevent such an entryfrom occurring.Case 1.2 - WorldCom: The Revenue Recognition Principle6Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-HillEducation.4.
Consult Paragraph 25 of PCAOB Auditing Standard No. Define what is meantby control environment. Next explain why the control environment is so importantto effective internal control over financial reporting at an audit client likeWorldCom.The control environment sets the tone for the organization and provides a platform or afoundation for the entire internal control system. The control environment is influenced heavilyby a company’s management team and is therefore often referred to as “the tone at the top”.With respect to the control environment, the absolute key for management is to try and impactthe attitudes towards internal controls throughout the organization by setting the proper examplefor the organization to follow. Paragraph #25 of Auditing Standard No. 5 outlines the auditor’sresponsibilities to understand the control environment. Indeed, “because of its importance toeffective internal control over financial reporting, the auditor must evaluate the controlenvironment at the company.”Stated simply, the control environment has a “pervasive” effect on the reliability of financialreporting at WorldCom and all audit clients because it impacts ALL other components of anorganization’s internal control system.
The lack of an appropriate control environment sends amessage to all employees that management does not believe internal controls are important forefficiency and effectiveness of financial reporting.While a complete evaluation of the control environment at WorldCom is not possible withonly the case information, students should at least point out that Ebbers’ compensationphilosophy (with its focus on double digit revenue growth) should raise serious concerns abouttheir control environment. In fact, the WorldCom case provides a terrific context to illustratethat an organization’s compensation policy can also be used as a mechanism to foster anexcellent control environment. However, it does not appear that WorldCom has taken advantage.Case 1.2 - WorldCom: The Revenue Recognition Principleof this opportunity. Overall, by the end of class discussion, it should be clear that a propercontrol environment provides a foundation for the entire internal control system.5. Consult Paragraphs 6–7 of PCAOB Auditing Standard No. If you were auditingWorldCom, what type of documentary evidence would you require to evaluate thevalidity and propriety of a top-side journal entry made to the revenue account?Top-side journal entries are adjustments that are typically made by top management at thecorporate level.
According to the AICPA, these adjustments are typically made at the end of thefinancial reporting period and are not always posted to the general ledger.1Often, these entriesare not directly associated with actual economic activity as they do not emanate from thebusiness operations of a division or a business unit. These types of entries have been usedfrequently in the past by upper managers as a manner in which to perpetrate fraud. As a result,they often result in a fraud risk that must be addressed in a skeptical manner by auditors. Indeed,Paragraph #7 of PCAOB Auditing Standard No. 13 explicitlystates that the “auditor's responsesto the assessed risks of material misstatement, particularly fraud risks, should involve theapplication of professional skepticism in gathering and evaluating audit evidence.”In evaluating the propriety of a top-side journal entry, an auditor would want to firstinterview management and review any set policies and procedures related to top-side journalentries. The auditors would also want to vouch the supporting documentation for economicsubstance and ensure that it has been properly entered in the financial statements. If, forinstance, the top-side entries resulted in decreased depreciation due to increasing the salvagevalue of the trucks, the auditor may want to obtain written confirmation from an appraiser, orother evidence from a third party.
Students may discuss various examples and types of evidencethat would be required to evaluate the propriety of a “top-side” journal entry. Students’ answers1AICPA. “Journal Entries and Other Adjustments.” The CPA Letter/Public Accounting Firms.
June 2003.Case 1.2 - WorldCom: The Revenue Recognition Principleshould support their examples as in the example above. The absolute key for the auditor is toevaluate the economic substance of the entry with sufficient and competent evidence.6. Consult Paragraphs 1–2 of Ethics Rule 102 (ET 102). Next, consider the roles of RonLomenzo and Lisa Taranto. Assume that these employees knew that the entriesbeing proposed by Scott Sullivan were fraudulent; do you believe that Lomenzo andTaranto should have recorded the journal entries as directed by Sullivan? Why orwhy not?Ethics Rule 102 makes clear that a CPA must not “knowingly misrepresent facts” whencompleting his/her work. Indeed, according to Paragraph #1 of Ethics Rule 102 (ET 102), “inthe performance of any professional service, a member shall maintain objectivity and integrity,shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate hisor her judgment to others.” This rule extends to situations where the CPA knows another personis making the false journal entries.
Consider that Paragraph #2 states that a “member shall beconsidered to have knowingly misrepresented facts” when he/she “makes, or permits or directsanother to make, materially false and misleading entries in an entity’s financial statements orrecords.”As a result, for CPAs, the standards are entirely clear. If Lomenzo and Taranto knew that theentries were fraudulent, the ethical decision would be to not record the entries. While the easierdecision may be to follow Sullivan’s orders, it is clearly not the right decision.