Liabilities

08/05/2010

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Liabilities

08/05/2010

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Liabilities
Auditing liabilities is more difficult than auditing assets. When testing assets, the auditor can generally start with the items recorded in the accounting records and verify their existence through physical examination or other means. But with liabilities, the auditor must look for debts that should have been recorded but weren’t. Many of my students have trouble understanding tests of completeness. I spend a lot of time explaining and re-explaining why auditors select samples of January cash payments and trace them to December 31 accounts payable.

I have tried without success to find a good case in one of the accounting education journals that teaches students how to test accounts payable. If I’ve overlooked such a case, please post a comment below.

Articles:
“Accounts Payable Fraud: Ten Ways to Identify It,” Christine Warner, New Perspectives (Summer 2007): 14-17. This article explains audit procedures to identify accounts payable fraud such as searching for duplicate payments, round-amount invoices, abnormal invoice volume, and invoices just below approval amounts.

Cases:
“Garbage In, Garbage Out Waste Disposal Incorporated: An Audit Case,” Srinivasan Ragothaman, William Wilcox & Thomas Davies, Issues in Accounting Education (August 2003): 307-316. A fictitious waste disposal company manages its earnings by manipulating its depreciation expense and environmental liabilities.


















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Other Assets

08/05/2010

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Other Assets
After teaching my students how to audit sales, accounts receivable, and inventory, I rarely have enough time to talk about other assets. That’s too bad because Issues in Accounting Education has published some interesting cases recently dealing with assets such as mining properties, foreign bank accounts, line cost accruals, depreciable fixed assets, and investment securities.

Cases:
“Sky Scientific, Inc.: An Auditing Minefield,” Stephen BeMiller, Randy Wirtz & Deborah Lindberg, Issues in Accounting Education (May 2009): 219-236. Describes an actual company that overstated the value of its mining properties and foreign bank deposits. The case addresses audit planning, the evaluation of management representations, the responsibilities of the concurring auditor, and the auditor’s going-concern judgments.

“Behind Closed Doors at WorldCom: 2001,” Kay Zekany, Lucas Braun & Zachary Warder, Issues in Accounting Education (February 2004): 101-117. Describes the fraud at WorldCom. Students must evaluate WorldCom’s revenue recognition practices and line cost accruals.

“Garbage In, Garbage Out Waste Disposal Incorporated: An Audit Case,” Srinivasan Ragothaman, William Wilcox & Thomas Davies, Issues in Accounting Education (August 2003): 307-316. A fictitious waste disposal company manages its earnings by manipulating its depreciation expense and environmental liabilities.

“Laborers Local 829 Health and Welfare Plan: Testing Investments and Receivables,” Thomas Hogan, James Bierstaker & William Seltz, Issues in Accounting Education (November 2001): 637-649. Students must plan and perform audit tests of investments and receivables at a multi-employer health care provider.

 
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Accounts Receivable

08/03/2010

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Accounts Receivable
I tell my students that testing the existence of accounts receivable is relatively easy. By sending confirmation requests and examining documentation we should be able to obtain reliable evidence about whether somebody owes our client money. The hard part is testing valuation. Can our client collect the amount due? The first two articles listed below provide advice for testing the client’s allowance for doubtful accounts. The third article suggests that auditors don’t always test that account very well. 

Articles:
“Assessing the Allowance for Doubtful Accounts,” Mark Riley & William Pasewark, Journal of Accountancy (September 2009): 40-44. This article describes 3 techniques for evaluating past estimates of the allowance for doubtful accounts.

“A Reserve Against Loan Defaults,” Thomas Stanley, John Lajaunie & David Meeting, Internal Auditor (June 2009): 43-47. This article explains accounting rules and audit procedures for loan loss reserves.

“Dear CFO: Watch Your Loan Loss Reserves,” Marie Leone, CFO.com (August 21, 2009).  In its annual inspection reports, the PCAOB criticized, among other firms, Deloitte, KPMG, and McGladrey & Pullen for not doing adequate testing on their clients' reserves.

Cases:
“The SEC’s Case Against California Micro Devices: A Lesson in Using Professional Skepticism and Obtaining Sufficient Appropriate Evidence,” Jill D’Aquila & Kim Capriotti, Issues in Accounting Education (February 2011): 145-154. Students must evaluate the audit procedures performed by Coopers & Lybrand to test California Micro Devices’ accounts receivable.

“Laborers Local 829 Health and Welfare Plan: Testing Investments and Receivables,” Thomas Hogan, James Bierstaker & William Seltz, Issues in Accounting Education (November 2001): 637-649. Students must plan and perform audit tests of investments and receivables at a multi-employer health care provider.

 
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Sales

06/04/2010

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Sales
I always spend a full week talking about testing revenue transactions. SAS No. 99 requires auditors to presume a risk of revenue fraud. The most recent COSO study, Fraudulent Financial Reporting: 1998-2007, found that 60 percent of the accounting fraud cases settled by the SEC involved improper revenue recognition.

I assign students to read at least two of the articles listed below under “Examples of Sales Fraud” and identify procedures the auditors should have performed to detect the sales fraud. Each article is excellent. I have used each one many times and have always had good class discussions.

The MicroStrategy and Chase Industries cases require students to evaluate unfamiliar revenue recognition policies. They are good for instructors who want students to practice their professional research skills.

The Vouch and Trace case is good for instructors who do not assign an audit practice set. A website provides a set of sales orders, sales invoices, and shipping documents for students to examine to find seeded misstatements.

Articles:
“Auditor Skepticism and Revenue Transactions,” Jimmy Martin, CPA Journal (August 2002): 31-38. This article summarizes several SEC Accounting and Auditing Enforcement Releases dealing with bill-and-hold transactions, side agreements, improper sales cutoff, sales returns, and fictitious revenue.

Examples of Sales Fraud:
“Accusers Charge Former Chief of HPL Technologies with Fraud,” Mary Anne Ostrom, San Jose Mercury News (September 11, 2002). HPL co-founder David Lepejian forged customers’ signatures and altered bank statements to fabricate 80% of HPL’s reported revenues prior to the company’s IPO.

“Time Was Money,” Sandra Sugawara, Washington Post (September 28, 2000): E1. Officials at Sirena Apparel Group reset the computer’s clock to put a March 31 date on sales invoices generated in April.

“Anatomy of a Fraud,” Mark Maremont, Business Week (September 16, 1996): 90-93. Kurzweil President Bernard Bradstreet forged sales documents and confirmations to record millions of dollars of phony sales.

“How Barry Minkow Fooled the Auditors,” Daniel Akst, Forbes (October 2, 1989): 126-132. An entertaining account of how Barry Minkow deceived his auditors into believing that ZZZZ Best was performing building restoration projects.

Cases:
“The Central Florida Emphysema Foundation Audit,” A Case Study of Personal and Professional Responsibility,” Patrick Knipe & Michael Bitter, Issues in Accounting Education (May 2011): 377-89. An in-charge (senior) auditor must decide whether to permit a client to recognize revenue for a large bequest received after year-end.

“Vouch and Trace: A Revenue Recognition Audit Simulation,” Tad Miller and Arline Savage, Issues in Accounting Education (February 2009): 93-103. Students test transactions recorded in a fictitious company’s sales journal using sales orders, invoices, shipping documents and price lists available on the Internet.

“Putting the Clock Back: MicroStrategy, Inc.” Patricia Williams & Bruce Koch, Issues in Accounting Education (May 2004): 249-260. Students must evaluate MicroStrategy’s revenue recognition policies.

“Chase Industries,” Robert N. West, Issues in Accounting Education (November 1998): 1031-1042. Students must evaluate an audit client’s justification for recording bill-and-hold sales.
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Inventory

06/04/2010

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Inventory
I show the AICPA video Auditing Inventory on the first day we talk about inventory. It’s the best way I have found to convey the difficulty of walking through a huge warehouse filled with thousands of items and trying to verify that all the items have been identified properly and counted correctly.

I read ASR No. 196 more than 25 years ago when I was in staff training at Deloitte. It is still my favorite example of how not to audit inventory. 

The Straka Internal Auditor article and the Schneider Management Accounting article provide great “teaser” questions for when I have a few minutes left at the end of class. “Imagine you were auditing a timber company that owned thousands of acres of timberland. How would you estimate the volume of wood owned by your client? Or “imagine you were auditing a sand and gravel company whose inventory was piled in enormous mounds 80 feet high and one-quarter mile in diameter. How would you verify the value of your client’s inventory?”

Articles:
“Ghost Goods: How to Spot Phantom Inventory,” Joseph T. Wells, Journal of Accountancy (June 2001): 33-36. This article provides advice for assessing the risk of inventory fraud, observing physical inventory counts, and performing analytical procedures related to inventory.

“Auditing Timber Assets,” Thomas Straka, Internal Auditor (June 1995): 50-54. This article describes the unique challenges of controlling and auditing timber.

“Shoot Your Inventory,” Dennis Schneider, Management Accounting (September 1989): 37-39. This article describes how a sand and gravel company uses aerial photography to measure its inventory.

Instructional Video:
Auditing Inventory, AICPA Product #738912HS. This interactive CPE self-study course includes a video of the physical inventory count at a small electronics manufacturer.

Examples of Inventory Misstatements:
“Aspiring Midas Enmeshes Auditors in Gold Chain,” Jeff Opdyke, Wall Street Journal (March 1, 2002): C1. A gold importer duped his auditors into believing that gold-plated costume jewelry was 24-carat gold.

“In the Matter of Seidman & Seidman,” Accounting Series Release No. 196, Securities and Exchange Commission (September 1, 1976). Auditors from Seidman & Seidman failed to detect that Cenco, Inc.’s inventory was overstated by 50 percent.

Cases:
“Accounting Fraud at CIT Computer Leasing Group, Inc.” Jeffrey Michelman, Victoria Gorman & Gregory Trompeter, Issues in Accounting Education (August 2011): 569-591. This case describes a newly promoted manager’s search for inventory fraud perpetrated by her supervisor. The materials include videotaped interviews with the investigators and prosecutor.

“J&K Fitness Supply Company: Auditing Inventory,” Paul Clikeman, Accounting Education: An International Journal (April 2012): 161-170. Simulated inventory source documents are provided on a web site. Students analyze the count tags, test counts, vendor invoices, and perpetual inventory records to evaluate the client’s inventory account balance.

“Dynamic Data: Corporate Governance and Auditors’ Evaluation of Accounting Estimates,” Jeffrey Cohen, Ganesh Krishnamoorthy & Arnold Wright, Issues in Accounting Education (February 2005): 119-128. Students must evaluate whether an inventory writedown is necessary at a high-tech data networking firm.

“Perry Drugs Stores, Inc.: Accounting and Control Issues for Inventory in a Retail Environment,” Michael C. Knapp & Carol A. Knapp, Issues in Accounting Education (May 2000): 237-255. Describes Perry’s decision to account for a $20 million book-to-physical inventory adjustment as a change in estimate.
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