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Caplin, Kolby

Hart, Timothy
Knott, Joseph
Zablocki, Dylan

Audit 401.002

Audit Cases 1.1, 1.5, 2.2, 3.7, 4.5, 5.6


Case 1.1 Q #4 Consult Paragraphs 56 of PCAOB Auditing Standard No. 15. As an
auditor, what type of evidence would you want to examine to determine whether Waste
Managements decision to change the useful life and salvage value of its assets was
appropriate under GAAP?

PCAOB Auditing Standard No. 15 paragraph 5 states the need for sufficient evidence.
Which is the proper quantity of audit evidence needed and is based on two requirements: risk of
material misstatement and the quality of the evidence obtained. PCAOB Auditing Standard No.
15 paragraph 5 says:
5. Sufficiency is the measure of the quantity of audit evidence. The quantity of audit
evidence needed is affected by the following:
Risk of material misstatement (in the audit of financial statements) or the risk
associated with the control (in the audit of internal control over financial reporting). As
the risk increases, the amount of evidence that the auditor should obtain also increases.
For example, ordinarily more evidence is needed to respond to significant risks.2/
Quality of the audit evidence obtained. As the quality of the evidence increases,
the need for additional corroborating evidence decreases. Obtaining more of the same
type of audit evidence, however, cannot compensate for the poor quality of that
evidence.
PCAOB Auditing Standard No. 15 paragraph 6 states the need for appropriate evidence.
This ties back to the quality of the audit evidence in that it must be relevant and reliable to
support the conclusion of the auditor. PCAOB Auditing Standard No. 15 paragraph 6 says:
6. Appropriateness is the measure of the quality of audit evidence, i.e., its relevance and
reliability. To be appropriate, audit evidence must be both relevant and reliable in
providing support for the conclusions on which the auditor's opinion is based.
The need for sufficient and appropriate audit evidence would be alleviated with the use of
substantive procedures. Reviewing depreciation policies set forth in company manuals or other
management directives would be the first step to determine whether Waste Managements
decision to change the useful life and salvage value was appropriate under GAAP. Second,
obtaining a summary analysis of accumulated depreciation for the major property classifications.
Third, Test the provisions of depreciation with tests of computations for accumulated
depreciation and trace them back to individual accounts. Fourth, test deductions from
accumulated depreciation for retired assets. Finally, perform ending analytical procedures for
depreciation (Whittington, 561).
These five substantive procedures performed would lower the risk of material
misstatement and increase the quality of evidence; also satisfying the requirements set forth in
PCAOB No. 15. This would enable the auditor to detect the fraud committed by top management
at Waste Management in altering the salvage and useful lives of their depreciable assets.

Case 1.5 Waste Management: The Definition of An Asset


Q#4 Consult Paragraph 10 of PCAOB Auditing Standard No. 15. As an auditor, what type
of evidence would allow you to detect whether your client was engaging in behaviors that
are designed to mask fraudulent behavior (such as basketing, bundling, or netting)?

When looking at identifying fraud an auditor first must know what an an asset is. An
asset is a likely future economic benefit obtained or controlled by a particular entity as a result of
past transactions or events. (Thibodeau, 23) To detect whether your client was engaging in
behaviors that are designed to mask fraudulent behavior PCAOB Auditing Standard No. 15
paragraph 6 says:
the auditor should evaluate whether the information is sufficient and appropriate for
purposes of the audit by performing specific procedures.
These procedures include testing the accuracy and completeness of the information, or
testing the controls over the accuracy and completeness of that information. Also, evaluating
whether the information is sufficiently precise and detailed for purposes of the audit.(PCAOB,
Auditing Standard No. 15)
Waste Management did not adhere to the guidelines of PCAOB auditing standard No.
15.. The standards broken included repeated changes to depreciation-related estimates and
improper accounting practices related to capitalization policies.Waste Management was found
guilty of the following:
The SEC brought charges against the companys founder, Dean Buntrock, and five
other former top officers. The charges alleged that management had made repeated changes to
depreciation-related estimates to reduce expenses and had employed several improper
accounting practices related to capitalization policies, also designed to reduce expenses.
(SEC, Accounting and Auditing Enforcement Release No. 1532, March 26, 2002)
The Standard states the procedures must be tested for accuracy and completeness of
information. The company did not follow these guidelines because they did not state the
information accurately. The company changed the depreciation estimates multiple times which is
not accurate.
Case 2.2 Waste Management: Due Care
Q# 1 What is auditor independence, and what is its significance to the audit profession? In
what ways, if any, was Arthur Andersens independence potentially impacted on the Waste
Management audit?

Auditor Independence from the client is required for attestation services under PCAOB
Rule 3520, which states, A registered public accounting firm and its associated persons must be
independent of the firm's audit client throughout an audit and professional engagement period
(PCAOB, Rule 3520). Auditor Independence is critical to the profession because it maintains the
publics confidence in the profession. Without strict guidelines on independence, users of
financial statements would not be able to know if the statements are properly stated or reported
on fairly. Both the Arthur Andersen firm and its associates failed to maintain independence with
respect to Waste Management. Independence was impaired because of contingent fees and
employees leaving Arthur Andersen for Waste Management in an inappropriate fashion.
A specific independence rule broken by the Arthur Andersen firm is the PCAOBs rule
on contingent fees. The rule states that in order to maintain independence, a registered public
accounting firm may not provide any service to an audit client for contingent fee, whether
directly or indirectly (PCAOB, Rule 3521). The case states that Arthur Andersen audited the
company between 1991 and 1997, while also providing $11.8 million in fees for other
professional services and special work, during the same years (Thibodeau, 60). The case does
not specify what professional services or special work was performed for Waste Management,
and this leads to an independence impairment in appearance. The SEC rules on independence
state a firm is not independent if a reasonable investor would conclude that the firm cannot
exercise objective and impartial judgement (SEC, Independence Requirement). A reasonable
investor would not conclude that Arthur Andersen is independent in appearance due to the firm
receiving contingent fees for unspecified special work.
Independence rules were also violated because over 14 employees and, every CFO and
CAO employed by Waste Management had previously worked as an auditor at Arthur
Andersen, (Thibodeau, 60). The AICPAs Code of Conduct, section 1.279.020 states that a
former auditor in a key position at a client may impair independence of the firm for multiple
reasons, including being in a position to influence the firms practices (AICPA, Code of
Conduct, 1.279.020). A reasonable investor would conclude that Waste Management employing
14 former auditors, and in key positions such as CFO and CAO, would appear to impair
independence of the firm. The CPA firm should also perform additional procedures to determine
that the all of the works of the CPAs were performed with objectivity and integrity before their
departure to Waste Management (Whittington, 85). Arthur Andersen did not take the necessary
steps to ensure that its independence was not affected by its former employees working for
Waste Management.

Case 3.7 Waste Management: Understanding the Clients Business and Industry
Q #1. Consult Paragraphs 58 of PCAOB Auditing Standard No. 8 and Paragraphs 710 of
PCAOB Auditing Standard No. 12. Based on your understanding of inherent risk
assessment and the case information, identify three specific factors about Waste
Management that might cause you to elevate inherent risk. When identifying each factor,
indicate the financial statement account that is likely to be most affected (and briefly
discuss why it is most affected).
PCAOB Auditing Standard No. 8 defines inherent risk as Inherent risk, which refers to
the susceptibility of an assertion to a misstatement, due to error or fraud, that could be material,
individually or in combination with other misstatements, before consideration of any related
controls. Inherent risk for the business would be determined using a risk assessment. The need
for relevant and reliable evidence to create this risk assessment is a key factor. In this case the
information used would be provided by the client meaning is reliability is not as high as other
types of evidence (PCAOB, Auditing Standard No. 12). Three factors should have caused the
auditor to increase inherent risk due to the risk of misstatement and the unreliability of evidence
form the client.
The first of three factors is Waste Managements history of sustained growth over a thirty
year period. Waste Management grew revenue at 36 percent annual average and grew net income
at 36 percent annual average from 1971 to 1991. Losing this large amount of annual growth
would have surely scared management and should have been an obvious concern for auditors.
The second of three factors that might cause an elevation in inherent risk would be Waste
Management business expanded their company into new and international operations. Once
Waste Management expanded operations to seven different and much more complicated
processes they saw decreases in growth (Thibodeau, 111). This can be seen in the poor
performance of the International Waste Management revenue account. Waste Management
expected around 26% growth annually from all newly organized operations. However, these
newly organized operations did not come close to these estimations, operations performed
severely under estimations with below 10% growth.
The last of the factors include new government regulations and increased competition.
Regulations have added to the cost of operating a landfill and made it more difficult and
expensive for Waste Management to obtain permits for constructing new landfills or to expand
old ones. (Thibodeau, 111) This will affect net income because not only will it be harder to
obtain permits but these regulations make everything more expensive which only harms net
income. The increased competition in the core North American region has hurt profitability and
caused landfills to not be filled. Specifically affecting the solid waste management growth.
Slowing the down annual below estimates. Waste Management had thirty years of low
competition due to their constant acquisition of other firms. As they began to face fierce
competition in their main operating region it would have increased the risks of fraud to hide the
failures.
Case 4.5 Waste Management: Top-Side Adjusting Journal Entries
Q #1 Consult Paragraphs 1415 of PCAOB Auditing Standard No. 13. If you were auditing
Waste Management, what type of documentary evidence would you require to evaluate the
propriety of a top-side adjusting journal entry?

Waste Managements actions were deliberately set forth by upper-level management to


increase their value to shareholders by intentionally hiding their fraud from their operating
groups. AU section 316 describes three procedures that addresses this risk of management
override. These procedures include examining journal entries and other adjustments for
evidence of material misstatement due to fraud, reviewing accounting estimates for biases that
could result in material misstatement due to fraud, and evaluating whether the business purpose
for significant transactions that are outside the normal course of business for the company or that
appear to be unusual due to their timing, size, or nature. (PCAOB, Auditing Standards No. 13)
It would be important for the auditor to analyze and compare documents related to
economic substance to confirm that they have been entered correctly in the financial statements.
An example of a document to examine would be sales invoices. Comparing the total amount of
the sale to what is journalized in the sales journal and posted in the accounts receivable ledger
would provide the opportunity for the auditor to detect any fraud within their operating
segments.
If Waste Managements top management team is making top-side adjusting journal
entries to decrease the depreciation of their assets then the auditor would want to examine any
documents pertaining to the value of the particular asset being adjusted. For example, if an
appraiser values machinery at a value other than what is journalized then there is evidence of
possible fraud. An auditor should use the top down approach to evaluate such situations. The
auditor should use the top down approach to the audit of internal control over financial reporting
to select the controls to test (PCAOB Auditing Standards No. 5) This approach begins with
interviewing upper-level management on the risks of internal control followed by an examination
of entity level controls. Procedures the auditor performs to test operating effectiveness include
a mix of inquiry of appropriate personnel, observation of the company's operations, inspection of
relevant documentation, and re-performance of the control. (PCAOB Auditing Standards No.
13). If the system is operating correctly then the auditor should examine any documents that
have economic substance to the entries posted in the journals. Documentation could include
appraisal values, cash receipts, and purchase orders.
Case 5.6 Waste Management: Valuation of Fixed Assets
Q #4 Consult Sections 302 and 305 and Title IX of SARBOX. Do you believe that these
provisions will help deter fraudulent financial reporting by a top management group such
as that of Waste Management? Why or why not?

The Sarbanes-Oxley Act of 2002 has many provisions that may have prevented the fraud
committed by senior management at Waste Management and Arthur Andersen. Sections 302 and
305 of the Sarbanes-Oxley Act heighten the responsibility of companies management with
regards to financial reporting and internal control, and Title IX adds more consequences for
those who commit financial fraud.
The main fraud charges brought against Waste Management were that, that top
management had made several top-side adjustments in the process of consolidating the results
reported by each of the operating groups and intentionally hid these adjustments from the
operating groups themselves, (Thibodeaux, 164). Section 302 of Sarbanes-Oxley specifically
requires that top signers make all internal controls and material information available to officers
in companies subsidiaries, (Sarbanes-Oxley Act, Section 302). This provision would allow
Waste Management's subsidiaries officers to be aware of the fraudulent accounting practices
that top-management was committing. The officers awareness of top-managements fraud
could have deterred the practice and prevented the loss of billions of dollars from shareholders
and investors.
Waste Management also used accounting such as netting, and geography, which
essentially made it harder for auditors to compare operating results over time, and authorized
several false and misleading disclosures in the financial statements, (Thibodeaux, 164). Section
302 of Sarbanes Oxley states that management must disclose all fraud involving management
and other significant employees to auditors (Sarbanes-Oxley, Section 302). Failure to report
these known fraudulent activities warrants consequences under Title IX of the Sarbanes Oxley
Act.
Title IX adds stiff penalties to those who commit and conceal financial fraud which could
have deterred the fraud committed by Waste Management. Section 902 of Title IX makes it so
those who attempt to commit or conspire financial fraud are subject to the same penalties under
U.S. Code 18, 1348, which states that those guilty will be charged with up to 25 years in federal
prison (Sarbanes-Oxley, Section 902)(US Code 18, 1348). Section 906 also adds penalties for
CEOs and CFOs who fail to provide a written statement certifying that the financial statements
are in accordance with the Securities and Exchange act of of 1934, and that they present fairly in
all material aspects (Sarbanes-Oxley, Section 906). The penalties for failing to provide this
statement are a fine up to $1 million, and/or prison up to ten years, and the knowling falsifying
this statements leads up to a $5 million fine, and/or 20 years in prison (Sarbanes-Oxley, Section
906). These penalties would have deterred the top-management of Waste-Management from
committing such fraudulent activities.
Works Cited

"Auditing and Related Professional Practice Standards." PCAOB, n.d. Web. 02 May

2017.

"Code of Professional Conduct, Section 1.279.020." American Institute of Certified

Public Accountants, n.d. Web. 02 May 2017.

"Revision of the Commission's Auditor Independence Requirements." Securities and

Exchange Commission, n.d. Web. 02 May 2017.

"The Sarbanes-Oxley Act of 2002." The Sarbanes-Oxley Act. N.p., n.d. Web. 04 May

2017.

Thibodeau, Freier. AUDITING AND ACCOUNTING CASES: Investigating Issues of

Fraud and Professional Ethics. 4th ed. S.l.: MCGRAW-HILL, 2014. Print.

Whittington, Ray, and Kurt Pany. Principles of Auditing and Other Assurance Services.

Boston: Irwin/McGraw-Hill, 2001. Print.

"18 U.S. Code 1350 - Failure of Corporate Officers to Certify Financial Reports." LII /

Legal Information Institute. Cornell University, n.d. Web. 04 May 2017.