Solution Manual for Auditing Cases An Interactive Learning Approach, 6th Edition

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Auditing CasesS I X T HE D I T I O NResource ManualMark S. BeasleyFrank A. BucklessSteven M. GloverDouglas F. Prawitt

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T A B L EO FC O N T E N T SiCASES INCLUDED IN THIS SECTIONClient AcceptanceS E C T I O N11.1Ocean Manufacturing, Inc............................9The New Client Acceptance DecisionCASES INCLUDED IN THIS SECTIONUnderstanding the Client’s Businessand Assessing RiskS E C T I O N22.1Your1040Return.com..............................21Evaluating eBusiness Revenue Recognition, Information Privacy,and Electronic Evidence Issues2.2Apple Inc......................................33Evaluation of Client Business Risk2.3Flash Technologies, Inc.............................43Risk Analysis2.4Asher Farms Inc..................................57Understanding of Client’s Business EnvironmentCASES INCLUDED IN THIS SECTIONProfessional and Ethical IssuesS E C T I O N33.1A Day in the Life of Brent Dorsey.......................67Staff Auditor Professional Pressures3.2Nathan Johnson’s Rental Car Reimbursement................71Should He Pocket the Cash?3.3The Anonymous Caller.............................75Recognizing It’s a Fraud and Evaluating What to Do3.4WorldCom.....................................83The Story of a Whistleblower3.5Hollinger International.............................91Realities of Audit-Related LitigationI N T R O D U C T I O NProfessional Judgment................1

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T A B L EO FC O N T E N T SiiCASES INCLUDED IN THIS SECTIONAccounting Fraud and Auditor Legal LiabilityS E C T I O N44.1Enron Corporation and Andersen, LLP..................103Analyzing the Fall of Two Giants4.2Comptronix Corporation...........................113Identifying Inherent Risk and Control Risk Factors4.3Cendant Corporation.............................127Assessing the Control Environment and Evaluating Risk ofFinancial Statement Fraud4.4Waste Management, Inc............................135Manipulating Accounting Estimates4.5Xerox Corporation...............................145Evaluating Risk of Financial Statement Fraud4.6Phar-Mor, Inc..................................159Accounting Fraud, Litigation, and Auditor Liability4.7Satyam Computer Services Limited.....................175Controlling the Confirmation ProcessCASES INCLUDED IN THIS SECTIONInternal Control over Financial ReportingS E C T I O N55.1Simply Steam, Co................................185Evaluation of Internal Control Environment5.2Easy Clean, Co..................................185Evaluation of Internal Control Environment5.3Red Bluff Inn & Café..............................195Establishing Effective Internal Control in a Small Business5.4St. James Clothiers...............................199Evaluation of Manual and IT-Based Sales Accounting System Risks5.5Collins Harp Enterprises...........................209Recommending IT Systems Development Controls5.6Sarbox Scooter, Inc...............................219Scoping and Evaluation Judgments in the Audit of InternalControl over Financial Reporting5.7Société Générale................................229How a Low-Risk Trading Area Caused a $7.2 Billion Loss

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T A B L EO FC O N T E N T SiiiCASES INCLUDED IN THIS SECTION2.1Your1040Return.com...........................21Evaluating eBusiness Revenue Recognition, Information Privacy,and Electronic Evidence Issues5.4St. James Clothiers...........................199Evaluation of Manual and IT-Based Sales Accounting System Risks5.5Collins Harp Enterprises........................209Recommending IT Systems Development Controls9.2Henrico Retail, Inc............................319Understanding the IT Accounting System and Identifying AuditEvidence for Retail SalesOTHER CASES THAT DISCUSS TOPICS RELATED TO THIS SECTIONThe Impact of Information TechnologyS E C T I O N66.1Harley-Davidson, Inc..............................241Identifying eBusiness Risks and Related Assurance Services forthe eBusiness Marketplace6.2Jacksonville Jaguars..............................251Evaluating IT Benefits and Risks and Identifying Trust ServicesOpportunitiesCASES INCLUDED IN THIS SECTIONOTHER CASES THAT DISCUSS TOPICS RELATED TO THIS SECTIONPlanning MaterialityS E C T I O N77.1Anne Aylor, Inc.................................267Determination of Planning Materiality and Tolerable Misstatement5.6Sarbox Scooter, Inc............................219Scoping and Evaluation Judgments in the Audit of InternalControl over Financial Reporting12.1EyeMax Corporation..........................439Evaluation of Audit Differences12.2Auto Parts, Inc..............................449Considering Materiality When Evaluating Accounting Policiesand Footnote Disclosures

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T A B L EO FC O N T E N T SivCASES INCLUDED IN THIS SECTIONOTHER CASES THAT DISCUSS TOPICS RELATED TO THIS SECTIONAnalytical ProceduresS E C T I O N88.1Laramie Wire Manufacturing.........................277Using Analytical Procedures in Audit Planning8.2Northwest Bank.................................283Developing Expectations for Analytical Procedures8.3Burlingham Bees................................291Using Analytical Procedures as Substantive Tests1.1Ocean Manufacturing, Inc..........................9The New Client Acceptance Decision2.3Flash Technologies, Inc..........................43Risk AnalysisCASES INCLUDED IN THIS SECTIONAuditing Cash, Fair Value, and RevenuesS E C T I O N99.1Wally’s Billboard & Sign Supply.......................299The Audit of Cash9.2Henrico Retail, Inc...............................319Understanding the IT Accounting System and Identifying AuditEvidence for Retail Sales9.3Longeta Corporation.............................327Auditing Revenue Contracts9.4Bud's Big Blue Manufacturing........................335Accounts Receivable Confirmations9.5Morris Mining Corporation.........................341Auditing Fair Value9.6Hooplah, Inc...................................349Applying Audit Sampling Concepts to Tests of Controls andSubstantive Testing in the Revenue Cycle9.7RedPack Beer Company...........................361Estimating the Allowance for Bad DebtsOTHER CASES THAT DISCUSS TOPICS RELATED TO THIS SECTION4.7Satyam Computer Services Limited..................1758.2Northwest Bank.............................2838.3Burlingham Bees............................291

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T A B L EO FC O N T E N T SvCASES INCLUDED IN THIS SECTIONPlanning and Performing Audit Proceduresin the Revenue and Expenditure CyclesAn Audit SimulationS E C T I O N1010.1Southeast Shoe Distributor, Inc.......................369Identification of Tests of Controls for the Revenue Cycle(Sales and Cash Receipts)10.2Southeast Shoe Distributor, Inc.......................383Identification of Substantive Tests for the Revenue Cycle(Sales and Cash Receipts)10.3Southeast Shoe Distributor, Inc.......................391Selection of Audit Tests and Risk Assessment for the Revenue Cycle(Sales and Cash Receipts)10.4Southeast Shoe Distributor, Inc.......................401Performance of Tests of Transactions for the Expenditure Cycle(Acquisitions and Cash Disbursements)10.5Southeast Shoe Distributor, Inc.......................417Performance of Tests of Balances for the Expenditure Cycle(Acquisitions and Cash Disbursements)CASES INCLUDED IN THIS SECTIONOTHER CASES THAT DISCUSS TOPICS RELATED TO THIS SECTIONDeveloping and EvaluatingAudit DocumentationS E C T I O N1111.1The Runners Shop...............................429Litigation Support Review of Audit Documentationfor Notes Payable9.1-6Section 9: Auditing Cash, Fair Value, and Revenues.........299Various Cases10.1-5Southeast Shoe Distributor, Inc....................369An Audit Simulation

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T A B L EO FC O N T E N T SviCASES INCLUDED IN THIS SECTIONCompleting the Audit, Reporting toManagement, and External ReportingS E C T I O N1212.1EyeMax Corporation..............................439Evaluation of Audit Differences12.2Auto Parts, Inc..................................449Considering Materiality When Evaluating Accounting Policiesand Footnote Disclosures12.3K&K Inc......................................455Leveraging Audit Findings to Provide Value-Added Insights in aManufacturing Environment12.4Surfer Dude Duds, Inc.............................461Considering the Going-Concern Assumption12.5Murchison Technologies, Inc.........................465Evaluating an Attorney’s Response and Identifying the ProperAudit Report12.6Going Green...................................477Sustainability and External Reporting

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viiA L P H A B E T I CC A S EI N D E X7.1Anne Aylor, Inc...............................................2673.3Anonymous Caller, The..........................................752.2Apple Inc....................................................332.4Asher Farms Inc...............................................5712.2Auto Parts, Inc...............................................4499.4Bud's Big Blue Manufacturing.....................................3358.3Burlingham Bees.............................................2914.3Cendant Corporation..........................................1275.5Collins Harp Enterprises........................................2094.2Comptronix Corporation.......................................1133.1Day in the Life of Brent Dorsey, A...................................675.2Easy Clean, Co...............................................1854.1Enron Corporation and Andersen, LLP..............................10312.1EyeMax Corporation...........................................4392.3Flash Technologies, Inc..........................................4312.6Going Green................................................4776.1Harley-Davidson, Inc...........................................2419.2Henrico Retail, Inc............................................3193.5Hollinger International..........................................919.6Hooplah, Inc.................................................3496.2Jacksonville Jaguars...........................................25112.3K&K, Inc...................................................4558.1Laramie Wire Manufacturing.....................................2779.3Longeta Corporation..........................................3279.5Morris Mining Corporation......................................34112.5Murchison Technologies, Inc.....................................4653.2Nathan Johnson’s Rental Car Reimbursement..........................718.2Northwest Bank..............................................2831.1Ocean Manufacturing, Inc........................................94.6Phar-Mor, Inc................................................1595.3Red Bluff Inn & Café...........................................1959.7RedPack Beer Company.........................................36111.1Runners Shop, The............................................4295.6Sarbox Scooter, Inc............................................2194.7Satyam Computer Services Limited................................1755.1Simply Steam, Co.............................................1855.7Société Générale.............................................22910.1Southeast Shoe Distributor, Inc.:Tests of Controls for the Revenue Cycle.............36910.2Southeast Shoe Distributor, Inc.:Substantive Tests for the Revenue Cycle.............38310.3Southeast Shoe Distributor, Inc.:Audit Tests and Risk Assessment for the Revenue Cycle.....39110.4Southeast Shoe Distributor, Inc.:Tests of Transactions for the Expenditure Cycle.........40110.5Southeast Shoe Distributor, Inc.:Tests of Balances for the Expenditure Cycle...........4175.4St. James Clothiers............................................19912.4Surfer Dude Duds, Inc..........................................4619.1Wally’s Billboard & Sign Supply...................................2994.4Waste Management, Inc.........................................1353.4WorldCom...................................................834.5Xerox Corporation............................................1452.1Your1040Return.com...........................................21

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viiiA C K N O W L E D G E M E N T SWe would like to thank our families for their understanding and support while writing this case-book. We would also like to thank Jonathan Liljegren for his excellent work in the design and layoutof this casebook as well as Karen Kirincich and Ellen Geary for their editorial support.We are grateful to the research assistants both past and present who have helped write,revise, and review the cases in this edition. We especially thank Truman Rowley and Kyle Stubbs fortheir assistance with this latest edition.

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ixP R E F A C EAuditing educators continue to look for opportunities to increase their emphasis on the developmentof students’ professional judgment, critical thinking, communication, and interpersonal relationshipskills. Development of these types of skills requires a shift from passive instruction to activeinvolvement of students in the learning process. Unfortunately, current course materials provided bymany publishers are not readily adaptable to this kind of active learning environment, or they do notprovide materials that address each major part of the audit process. The purpose of this casebook is togive students hands-on exposure to realistic auditing situations focusing specifically on each aspectof the audit process.This casebook contains a collection of 49 auditing cases plus a separate learning module aboutprofessional judgment that allow the instructor to focus and deepen students’ understanding in eachof the major activities performed during the conduct of an audit. Cases expose students to aspectsof the audit spanning from client acceptance to issuance of an audit report, with a particular focuson how professional judgment is applied throughout the audit. The cases are designed to engage thestudent’s interest through the use of lively narrative and the introduction of engaging issues. In somecases, supporting material in the instructor notes allows the instructor to create a “surprise” or “aha!”experience for the student, creating vivid and memorable learning experiences. Many of the casesare based on actual companies, some involving financial reporting fraud. Several cases give studentshands-on experience with realistic audit evidence and documentation. Each case contains a series ofquestions requiring student analysis, with numerous questions related to the guidance contained inauthoritative auditing standards.NEW TO THE SIXTH EDITIONThe sixth edition contains exciting new content that we believe will significantly enhance studentunderstanding of the audit process. For example, this new edition includes:A newLearning Module on Professional Judgmentthat exposes students to aprofessional judgment framework and outlines a framework of good judgment as well asa number of judgment tendencies and traps that can introduce bias into the judgmentprocess. Because professional judgments are required throughout the entire audit process,from client acceptance to report issuance, we included an Introduction to ProfessionalJudgment as an upfront learning module rather than as an individual case. We encouragestudents to complete this learning module early in their auditing course to expose themto the fundamentals of professional judgment, which they can use as they complete therequired professional judgment questions in many of the cases in this edition.New questions in many of the cases throughout the sixth edition to help students see theimportance of professional judgment in auditing. These questions are separately identifiedas"Professional Judgment Questions"and they challenge students to understand the criticalelements of an effective audit judgment process. A number of these questions raise studentawareness of potential judgment tendencies and traps that may lead to biased judgmentsif not appropriately considered. The materials also help students to understand steps thatcan be taken to mitigate potential biases.A new case,9.7 RedPack Beer Company, that exposes students to the challenges ofauditing accounting estimates, specifically the allowance for bad debts, at a hypotheticalbrewery. Students are provided the aged accounts receivable trial balance and other

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xaccounts receivable balance information including a transcript of the auditor's interviewof the company's credit manager about accounts included in the aging schedule. Studentsuse this information, along with the company's policy and procedures related to theallowance for bad debts, to evaluate the reasonableness of management's recorded estimate.Students are also asked to develop their own estimate and to propose any necessary auditadjustments.Updates to reflect new auditing standards issued by the AICPA's Auditing Standards Boardincluding the recently clarified auditing standards (AU-C) up through SAS No. 128,Usingthe Work of Internal Auditors, and the PCAOB’s Auditing Standards (up through AS No. 18,Related Parties). When relevant, questions expose students to new guidance contained inrecently issued auditing standards.New questions that introduce students to recent topical issues and their impact to theaudit process, such as: COSO’s 2013 updatedInternal Control – Integrated Framework,the impact of cloud computing on IT controls, and recently issued accounting standards.Cases based on events at real companies have been updated to reflect recent developmentsin the profession.Restructured questions in many cases to change the nature of the topics addressed andto expose students to different issues from those examined in prior editions. Many casesalso have reordered questions. Dates in the hypothetical cases have been set in calendaryear 2015 with audit procedures performed on the 2014 fiscal year information and/orinterim procedures performed on the 2015 fiscal year information. When appropriate,we have changed underlying data in the hypothetical cases so that the cases differ fromprior editions. All of these changes reduce the potential benefit of students seeking oursolutions from prior editions of the casebook. Further, students who inappropriatelyaccess and use solutions to prior editions are more likely to be detected by the instructor.APROPRIATE FOR BOTH UNDERGRADUATE AND GRADUATE AUDITING COURSESThe cases included in this book are suitable for both undergraduate and graduate students. At theundergraduate level, the cases provide students with active learning experiences that reinforce keyaudit concepts addressed by the instructor and textbook. At the graduate level, the cases providestudents with active learning experiences that expand the depth of their audit knowledge. Use of thecasebook will provide students with opportunities to develop a much richer understanding of theessential underlying issues involved in auditing, while at the same time developing critical thinking,communication, and interpersonal relationship skills.The casebook provides a wide variety of cases to facilitate different learning and teachingstyles. For example, several of the cases can be used either as in-class exercises or out-of-classassignments. The instructor resource manual accompanying the casebook clearly illustratesthe different instructional approaches available for each case (e.g., examples of cooperative/active learning activities and/or out-of-class individual or group assignments) and efficientlyprepares the instructor for leading interactive discussions. To access this manual, log on towww.pearsonhighered.com/beasley6e.We are pleased to provide this updated sixth edition and hope that the professional skills ofyour students will be enhanced through completion of cases contained within this edition.

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1The case was prepared by Mark S. Beasley, Ph.D. and Frank A. Buckless, Ph.D. of North Carolina State University and Steven M. Glover, Ph.D. andDouglas F. Prawitt, Ph.D. of Brigham Young University, as a basis for class discussion. It is not intended to illustrate either effective or ineffectivehandling of an administrative situation.Professional JudgmentUnderstanding and Developing Professional Judgmentin Auditing and AccountingMark S. Beasley·Frank A. Buckless·Steven M. Glover·Douglas F. Prawitt[1]To help students understand that the changingnature of the accounting profession increasinglyrequires professionals to use professional judg-ment (e.g., fair value measurements and princi-ples-based standards).[2]To help students gain an understanding of agood judgment process and practice using it inan accounting context.[3]To help students identify, recognize and mitigatecommon judgment traps and tendencies.[4]To help students gain an understanding ofprofessional skepticism by exploring judgmentframes.INSTR UCTIONAL OBJECTIVESBACKGROUNDKPMG LLP, one of the four largest international public accounting firms, launched an initiative in2009 to enhance the professional judgment and professional skepticism of its people and teams.KPMG collaborated with two professors at Brigham Young University, Professors Steve Gloverand Doug Prawitt, to emphasize these skills in its training. The result of this effort is refreshedprofessional judgment content throughout KPMG's audit training curriculum for all levels of auditprofessionals.KPMG took the additional step of sharing and leveraging its professional judgment trainingcontent to create, again in collaboration with Brigham Young University Professors Glover andPrawitt, a monograph to help students accelerate the development of their professional judgmentwhile still in college.The monograph is titled Elevating Professional Judgment in Auditing andAccounting: The KPMG Professional Judgment Framework. That monograph is available free ofcharge for college students and professors on KPMG’s University Connection site. (You can findthe monograph at http://www.kpmguniversityconnection.com). It is only available in electronicform because it comes as a pdf, with live internet links and audio files embedded. In addition, thereare video files and an instructor’s manual available separately to professors who register on KPMGUniversity Connection.This Professional Judgment Module is adapted from the KPMG Elevating ProfessionalJudgment in Auditing and Accounting monograph. It covers some of the topics that are discussedand illustrated in more depth in the monograph. This module can be used as an overview for themonograph and as a brief introduction to professional judgment for those who do not have space inI N T R O D U C T I O N

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2Section 2: Understanding the Client’s Business and Assessing Riskthe curriculum to assign the full monograph.The KPMG Professional Judgment Framework, from which this module is adapted withpermission from KPMG, LLP, was awarded the 2013 American Accounting Association/DeloitteWildman Award. The Wildman award, first presented in 1979, recognizes a work that the judgesview as “the most significant contribution to the advancement of the practice of public accountancy”published within the most recent 5-years.USE OF CASEThe Professional Judgment Introduction is a summary of the KPMG monograph titled, ElevatingProfessional Judgment in Auditing and Accounting: The KPMG Professional Judgment Framework.The full version of the monograph and accompanying instructor’s guide can be found at http://www.kpmguniversityconnection.com. Both the student version and the instructor’s guide containadditional links and resources that would be beneficial to students’ learning.This section of the casebook introduces students to the components of a good judgmentprocess. The introduction also discusses traps and biases that can threaten good judgment andsuggests common-sense ways to mitigate the effects of those threats.This section is recommended for use in undergraduate or graduate auditing and accountingcourses to introduce students to fundamental judgment concepts. It can be utilized in a variety ofways, depending on the amount of in-class time that is available. For example, all of the reading andwork could be assigned outside of class; or the cases found at the end of this section could be usedfor creating an in-class discussion.Additionally, as discussed in the preface, we have added various questions to many of the casesthat involve exercising the skills discussed and developed in this section. These question questionswill allow students to apply what they have learned in this section to a variety of circumstancessimilar to those that they will experience in their professional careers. Students will need to haveread this introduction in order to fully benefit from those questions.PROFESSIONAL STANDARDSPCAOB standards are referenced by standard number. Relevant professional standards for thisassignment are:PCAOB Standards:AU Section 230, “Due Professional Care in the Performance of Work”QUESTIONS AND SUGGESTED SOLUTIONS[1]Identify and describe two common judgment trapsRush to Solve and Judgment Triggers.Rush to solve occurs when professionals want to “getto a solution” quickly and as a result tend to skip the first step of the judgment process, whichinvolves identifying the problem or issue to be solved and specifying the objectives to beachieved. Likewise, decision triggers, which are often alternatives masquerading as a problemdefinition, tend to push the decision maker to fail to consider the problem definition andproblem objectives. Skipping this first step of the judgment process usually artificially limits thesize of the set of potential alternatives. This is important because a decision can only be as goodas the best alternative identified.[2]How can considering multiple judgment frames enhance an auditor’s professional skepticism?Explain and give an example.Evaluating issues and objectives from different frames can help auditors to understand avariety of different perspectives. Considering multiple frames can bring additional insightsor ways to understand a situation. It can also open up a variety of additional alternatives that

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3: Professional Judgmentmight not have been considered otherwise. For example, suppose that a client’s revenues haveincreased more than any other company in the industry and that the client attributes its successto a new marketing strategy. The auditor should understand the client’s explanation and thenapply professional skepticism by considering other possibilities, such as an error in revenuerecognition or even financial statement fraud. Considering financial results from that perspectivewill help the engagement team identify evidence that could help to either identify or rule out thepossibility of error or fraud.[3]What is the first step in avoiding traps or reducing bias? Briefly explain why this first step is soimportant.Awareness of potential traps and conditions that lead to bias is the most important factor—it isa necessary first step before any other efforts to mitigate bias can be implemented.[4]Identify and briefly describe three potential ways to mitigate the effects of biases.Activelyquestioningourassumptions,whichmightincludeconsideringpotentiallydisconfirming evidence or seeking more complete information, is a key approach in mitigatingall of the judgment biases. Consulting with others can go a long way toward mitigating theeffects of the availability tendency. Getting an outside view on a going-concern uncertaintyassessment can help keep the auditor’s judgment from being too optimistic, or pessimistic, givenrecent, salient experiences. In other judgment and decision tasks, a helpful approach is to askothers to gather and evaluate information without revealing our preference. (We do not wantto reveal our preference because it may affect their judgment just like it may affect our own.)Finally, we can also take steps to objectively evaluate the pros and cons for each alternative. Inmitigating bias related to the anchoring tendency, it can be helpful to seek out and explicitlyconsider alternative anchors.DISCUSSION CASES[1]An audit engagement team is planning for the upcoming audit of a client who recentlyunderwent a significant restructuring of its debt. The restructuring was necessary as economicconditions hampered the client’s ability to make scheduled re-payments of its debt obligations.The restructured debt agreements included new debt covenants. In auditing the debt obligationin the prior year (before the restructuring), the team established materiality specific to thefinancial statement debt account (account level materiality) at a lower amount than overallfinancial statement materiality. In planning the audit for the current year, the team plans touse a similar materiality level. While such a conclusion might be appropriate, what judgmenttrap(s) might the team fall into and which step(s) in the judgment process are most likelyaffected?The team needs to understand the terms of the debt restructuring. If the covenants in the newdebt agreements require the company to maintain certain financial ratios (for example, ratio ofassets to liabilities greater than 1.5 to 1), the appropriate account level materiality threshold maybe lower than the threshold used in the prior year when the debt agreement in place only requiredthe client to meet certain non-financial debt covenants. The traps that the team may have falleninto include both a rush to solve and a judgment trigger in that they may have considered onlythe same approach or alternative as was used in the prior year, even though conditions havechanged in important ways. The step in the judgment process most affected in this scenario isStep 2, “Consider Alternatives.”[2]A client is determining its accounting treatment for new types of long-term contracts. Considerthe differences in outcome for the two scenarios below regarding the approach the client and

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4Section 2: Understanding the Client’s Business and Assessing Riskauditor took. How does framing relate to the two different scenarios?Scenario A: The client entered into a large number of long-term sales contracts and recordedrevenue using an approach they determined was the preferred approach, with no consultationor discussion with the audit engagement team. The engagement team conducted revenuerecognition testing to ensure that the client correctly followed the chosen approach. Theengagement team noted that the client consistently and accurately applied the approach anddetermined that the audit testing supported the amount of revenue reported by the client.Scenario B: Before entering into long-term contracts with customers, the client reached out tothe audit engagement team to discuss the client’s preferred approach for recognizing revenue.The team researched authoritative accounting standards and considered the client’s preferredalternative. The team also considered other possible approaches and consulted with otherengagement teams with experience in accounting for long-term contracts. Based on this process,the engagement team determined that although the client’s preferred approach had merit,another alternative was more consistent with accounting principles for revenue recognition.The client carefully reconsidered the situation and ultimately decided to use the alternativesuggested by the engagement team to recognize revenue associated with the long-term contractsthey entered into.In Scenario A, the auditor appears to have adopted the client’s frame without consideringalternatives. While the client’s accounting treatment may have been correct, the auditor did notapply sufficient professional skepticism. In Scenario B, the auditor took time to understand theclient’s frame and then also challenged that frame by researching and considering alternativeperspectives. Considering more than one frame is the “stuff ” of professional skepticism.In Scenario B, rigorous application of professional skepticism led the engagement team torecommend a different revenue recognition accounting treatment.[3]For each of the two audit situations below, determine which judgment shortcut or tendency ismost prevalent and briefly describe the likely consequences of using the shortcut.[a]A staff auditor is testing accounts payable balances. The auditor observes an unexpectedfluctuation in the account balance compared to the prior year. The client happens to bewalking by, so the auditor asks the client about the fluctuation. The client provides a plausibleand reasonable explanation. In considering other possible causes for the fluctuation, theclient’s explanation seems to be the most likely, so the staff auditor documents it as evidencesupporting the fluctuation. Later, it is determined that other facts encountered during theaudit do not support the client’s explanation.It appears the staff auditor was influenced by the availability tendency in consideringthe client’s available and plausible explanation as most likely. The staff auditor may alsohave been vulnerable to the confirmation tendency. In this scenario, the availability andconfirmation tendencies led to shallow thinking, insufficient professional skepticism, lackof corroborating evidence, and weak documentation. Some of the ramifications for the auditcould include weak documentation—no corroboration of the client’s explanation, and lackof evidence of professional skepticism.[b]A client has provided the audit engagement team an estimate of the inventory valuationreserve. The client used a method for calculating the reserve that had been used in prioryears. To audit the reserve, the engagement team obtained and reviewed the client’scalculation. However, the team noted that the client’s calculation did not reflect a significantdecline in customer demand for an older product line that was losing popularity relativeto the newer products. The engagement team suggested that the client adjust the reserveupward. The client argued that the current reserve amount was adequate but indicated

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