Auditing A Risk Based-Approach to Conducting a Quality Audit 10th Edition Johnstone Solutions Manual
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Auditing A Risk Based-Approach to Conducting a Quality Audit 10th Edition Johnstone Solutions Manual
Auditing A Risk Based-Approach to Conducting a Quality Audit 10th Edition Johnstone Solutions Manual
Auditing A Risk Based-Approach to Conducting a Quality Audit 10th Edition Johnstone Solutions Manu...
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© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-1
Auditing: A Risk Based Approach to Conducting a Quality Audit, 10e
Solutions for Chapter 12
True/False Questions
12-1 F
12-2 T
12-3 T
12-4 T
12-5 T
12-6 T
12-7 T
12-8 F
12-9 T
12-10 F
12-11 T
12-12 F
12-13 F
12-14 T
12-15 T
12-16 T
Multiple-Choice Questions
12-17 D
12-18 A
12-19 D
12-20 A
12-21 B
12-22 D
12-23 B
12-24 C
12-25 A
12-26 D
12-27 C
12-28 A
12-29 B
12-30 C
12-31 C
12-32 B
12-1
Auditing: A Risk Based Approach to Conducting a Quality Audit, 10e
Solutions for Chapter 12
True/False Questions
12-1 F
12-2 T
12-3 T
12-4 T
12-5 T
12-6 T
12-7 T
12-8 F
12-9 T
12-10 F
12-11 T
12-12 F
12-13 F
12-14 T
12-15 T
12-16 T
Multiple-Choice Questions
12-17 D
12-18 A
12-19 D
12-20 A
12-21 B
12-22 D
12-23 B
12-24 C
12-25 A
12-26 D
12-27 C
12-28 A
12-29 B
12-30 C
12-31 C
12-32 B
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-2
Review and Short Case Questions
12-33
The existence and valuation assertions related to long-lived assets are usually the more relevant
assertions. Organizations may have incentives to overstate their long-lived assets and may do so
by including fictitious long-lived assets on the financial statements. Alternatively, organizations
may capitalize costs, such as repairs and maintenance costs, which should be expensed. Concerns
regarding valuation include whether the organization properly and completely recorded
depreciation and properly recorded any asset impairments. The valuation issues typically involve
management estimates that may be subject to management bias.
Identifying and focusing on the relevant assertions will allow the auditor to be more efficient in
the performance of the audit (i.e., the auditor will not over-audit the lower risk assertions and
will focus more effort on the higher risk assertions).
12-34
Depreciation expense relates to the expensing of a fixed asset over its life. For natural resources,
the related expense account would be referred to as depletion expense (the expense associated
with the extraction of natural resources). For intangible assets with a definite life, the related
expense account would be referred to as amortization expense.
12-35
The five management assertions relevant to long-lived assets are as follows:
1. Existence or occurrence. The long-lived assets exist at the balance sheet date. The focus
is typically on additions during the year.
2. Completeness. Long-lived asset account balances include all relevant transactions that
have taken place during the period.
3. Rights and obligations. The organization has ownership rights for the long-lived assets as
of the balance sheet date.
4. Valuation or allocation. The recorded balances reflect the balance that is in accordance
with GAAP (includes appropriate cost allocations and impairments).
5. Presentation and disclosure. The long-lived asset balance is reflected on the balance sheet
in the noncurrent section. The disclosures for depreciation methods and capital lease
terms are adequate.
12-36
Asset impairment is a term used to describe management’s recognition that a fixed asset is no
longer as productive as had originally been expected. When assets are impaired, the assets should
be written down to their expected economic value.
12-2
Review and Short Case Questions
12-33
The existence and valuation assertions related to long-lived assets are usually the more relevant
assertions. Organizations may have incentives to overstate their long-lived assets and may do so
by including fictitious long-lived assets on the financial statements. Alternatively, organizations
may capitalize costs, such as repairs and maintenance costs, which should be expensed. Concerns
regarding valuation include whether the organization properly and completely recorded
depreciation and properly recorded any asset impairments. The valuation issues typically involve
management estimates that may be subject to management bias.
Identifying and focusing on the relevant assertions will allow the auditor to be more efficient in
the performance of the audit (i.e., the auditor will not over-audit the lower risk assertions and
will focus more effort on the higher risk assertions).
12-34
Depreciation expense relates to the expensing of a fixed asset over its life. For natural resources,
the related expense account would be referred to as depletion expense (the expense associated
with the extraction of natural resources). For intangible assets with a definite life, the related
expense account would be referred to as amortization expense.
12-35
The five management assertions relevant to long-lived assets are as follows:
1. Existence or occurrence. The long-lived assets exist at the balance sheet date. The focus
is typically on additions during the year.
2. Completeness. Long-lived asset account balances include all relevant transactions that
have taken place during the period.
3. Rights and obligations. The organization has ownership rights for the long-lived assets as
of the balance sheet date.
4. Valuation or allocation. The recorded balances reflect the balance that is in accordance
with GAAP (includes appropriate cost allocations and impairments).
5. Presentation and disclosure. The long-lived asset balance is reflected on the balance sheet
in the noncurrent section. The disclosures for depreciation methods and capital lease
terms are adequate.
12-36
Asset impairment is a term used to describe management’s recognition that a fixed asset is no
longer as productive as had originally been expected. When assets are impaired, the assets should
be written down to their expected economic value.
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-3
Much of the inherent risk associated with long-lived assets is due to the importance of
management estimates, such as estimating useful lives and residual values and determining
whether asset impairment has occurred. Inherent risk related to asset impairment stems from the
following factors:
• Normally, management does not have incentives to identify and write down assets.
• Sometimes, management wants to write down every potentially impaired asset to a
minimum realizable value (although this will cause a one-time reduction to current
earnings, it will lead to higher reported earnings in the future).
• Determining asset impairment, especially for intangible assets, requires a good
information system, a systematic process, good controls, and professional judgment.
12-37
Natural resources present unique risks. First, it is often difficult to identify the costs associated
with discovery of the natural resource. Second, once the natural resource has been discovered, it
is often difficult to estimate the amount of commercially available resources to be used in
determining a depletion rate. Third, the client may be responsible for restoring the property to its
original condition (reclamation) after the resources are removed. Reclamation costs may be
difficult to estimate.
12-38
Intangible assets should be recorded at cost. However, the determination of cost for intangible
assets is not as straightforward as it is for tangible assets, such as equipment. As with tangible
long-lived assets, management needs to determine if the book values of patents and other
intangible assets have been impaired. Thus, there is a great deal of estimation by management
associated with intangible assets.
12-39
a. Management’s motivation to overstate fixed assets is similar to other circumstances in
which fraud is perpetrated:
• Increase reported earnings
• Boost stock price
• Improve ability of the company to acquire another company
• Avoid a violation of company debt covenants
b. The auditor should also consider the other two components of the fraud triangle–
opportunity and rationalization–when assessing fraud risk associated with long-lived assets.
12-3
Much of the inherent risk associated with long-lived assets is due to the importance of
management estimates, such as estimating useful lives and residual values and determining
whether asset impairment has occurred. Inherent risk related to asset impairment stems from the
following factors:
• Normally, management does not have incentives to identify and write down assets.
• Sometimes, management wants to write down every potentially impaired asset to a
minimum realizable value (although this will cause a one-time reduction to current
earnings, it will lead to higher reported earnings in the future).
• Determining asset impairment, especially for intangible assets, requires a good
information system, a systematic process, good controls, and professional judgment.
12-37
Natural resources present unique risks. First, it is often difficult to identify the costs associated
with discovery of the natural resource. Second, once the natural resource has been discovered, it
is often difficult to estimate the amount of commercially available resources to be used in
determining a depletion rate. Third, the client may be responsible for restoring the property to its
original condition (reclamation) after the resources are removed. Reclamation costs may be
difficult to estimate.
12-38
Intangible assets should be recorded at cost. However, the determination of cost for intangible
assets is not as straightforward as it is for tangible assets, such as equipment. As with tangible
long-lived assets, management needs to determine if the book values of patents and other
intangible assets have been impaired. Thus, there is a great deal of estimation by management
associated with intangible assets.
12-39
a. Management’s motivation to overstate fixed assets is similar to other circumstances in
which fraud is perpetrated:
• Increase reported earnings
• Boost stock price
• Improve ability of the company to acquire another company
• Avoid a violation of company debt covenants
b. The auditor should also consider the other two components of the fraud triangle–
opportunity and rationalization–when assessing fraud risk associated with long-lived assets.
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-4
12-40
A skeptical auditor will understand that management can manage earnings in a number of ways,
including:
• Improperly recording repairs and maintenance costs that should be expensed as fixed
assets.
• Lengthening the estimated useful lives and/or increasing estimated residual value of
depreciable assets without economic justification as was done in the Waste Management
fraud.
The auditor becomes aware of management’s potential by considering relevant fraud risk factors,
including incorporating information related to internal control effectiveness–in particular the
control environment.
12-41
Potential fraud schemes related to long-lived assets include:
• Sales of assets are not recorded and proceeds are misappropriated.
• Assets that have been sold are not removed from the books.
• Inappropriate residual values or lives are assigned to the assets, resulting in
miscalculation of depreciation.
• Amortization of intangible assets is miscalculated.
• Costs that should have been expensed are improperly capitalized.
• Impairment losses on long-lived assets are not recognized.
• Fair value estimates are unreasonable or unsupportable.
12-42
Typically, the more relevant assertions (areas of higher risk) for tangible long-lived assets (e.g.,
property, plant, and equipment) include existence and valuation. For these assertions, the
appropriate internal controls could include:
• The use of a computerized property ledger. The property ledger should uniquely identify
each asset. In addition the property ledger should provide detail on the cost of the
property, the acquisition date, depreciation method used for both book and tax, estimated
life, estimated scrap value (if any), and accumulated depreciation to date.
• Authorization procedures to acquire new assets. In particular, the use of a capital
budgeting committee to analyze the potential return on investment is a strong control
procedure.
• Periodic physical inventory of the assets and reconciliation with the recorded assets.
• Formal procedures to account for the disposal of assets.
• Periodic review of asset lives and adjustments of depreciation methods to reflect the
changes in estimated useful lives.
12-4
12-40
A skeptical auditor will understand that management can manage earnings in a number of ways,
including:
• Improperly recording repairs and maintenance costs that should be expensed as fixed
assets.
• Lengthening the estimated useful lives and/or increasing estimated residual value of
depreciable assets without economic justification as was done in the Waste Management
fraud.
The auditor becomes aware of management’s potential by considering relevant fraud risk factors,
including incorporating information related to internal control effectiveness–in particular the
control environment.
12-41
Potential fraud schemes related to long-lived assets include:
• Sales of assets are not recorded and proceeds are misappropriated.
• Assets that have been sold are not removed from the books.
• Inappropriate residual values or lives are assigned to the assets, resulting in
miscalculation of depreciation.
• Amortization of intangible assets is miscalculated.
• Costs that should have been expensed are improperly capitalized.
• Impairment losses on long-lived assets are not recognized.
• Fair value estimates are unreasonable or unsupportable.
12-42
Typically, the more relevant assertions (areas of higher risk) for tangible long-lived assets (e.g.,
property, plant, and equipment) include existence and valuation. For these assertions, the
appropriate internal controls could include:
• The use of a computerized property ledger. The property ledger should uniquely identify
each asset. In addition the property ledger should provide detail on the cost of the
property, the acquisition date, depreciation method used for both book and tax, estimated
life, estimated scrap value (if any), and accumulated depreciation to date.
• Authorization procedures to acquire new assets. In particular, the use of a capital
budgeting committee to analyze the potential return on investment is a strong control
procedure.
• Periodic physical inventory of the assets and reconciliation with the recorded assets.
• Formal procedures to account for the disposal of assets.
• Periodic review of asset lives and adjustments of depreciation methods to reflect the
changes in estimated useful lives.
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-5
12-43
For intangible assets, the client should have controls designed to:
• Provide reasonable assurance that decisions are appropriately made to capitalize
(completeness of assets) or expense (existence of assets) research and development
expenditures
• Develop amortization schedules that reflect the remaining useful life of intangible assets
such as patents or copyrights (valuation)
• Identify and account for intangible-asset impairments (valuation)
Management should have a monitoring process in place to review valuation of intangible assets.
For example, a pharmaceutical company should have fairly sophisticated models to predict the
success of newly developed drugs and monitor actual performance against expected performance
to determine whether a drug is likely to achieve expected revenue and profit goals. Similarly, a
software company should have controls in place to determine whether capitalized software
development costs will be realized. Exhibit 12.2 identifies examples of other controls over
intangible long-lived assets that clients may design and implement.
12-44
Analytical procedures that would be included as part of planning analytical procedures related to
depreciation expense include analysis of the following relationships, in the light the expectations
developed by the auditor:
• Current depreciation expense as a percentage of the previous year's depreciation expense,
• Fixed assets (by class) as a percentage of previous year's assets. The relative increase in
this percentage can be compared with the relative increase in depreciation expense as a
test of overall reasonableness.
• Depreciation expense (by asset class) as a percentage of assets each year. This ratio can
indicate changes in the age of equipment or changes in depreciation policy, or
computation errors.
• Accumulated depreciation (by class) as a percentage of gross assets each year. This ratio
provides information on the overall reasonableness of the account and may indicate
problems of accounting for fully depreciated equipment.
• Average age of equipment (by class). This ratio provides additional insight on the age of
assets and may be useful in modifying depreciation estimates.
12-45
Ratios and expected relationships that auditors can use when performing planning analytical
procedures include:
• Review and analyze gains/losses on disposals of equipment (gains indicate
depreciation lives are too short, losses indicate the opposite).
12-5
12-43
For intangible assets, the client should have controls designed to:
• Provide reasonable assurance that decisions are appropriately made to capitalize
(completeness of assets) or expense (existence of assets) research and development
expenditures
• Develop amortization schedules that reflect the remaining useful life of intangible assets
such as patents or copyrights (valuation)
• Identify and account for intangible-asset impairments (valuation)
Management should have a monitoring process in place to review valuation of intangible assets.
For example, a pharmaceutical company should have fairly sophisticated models to predict the
success of newly developed drugs and monitor actual performance against expected performance
to determine whether a drug is likely to achieve expected revenue and profit goals. Similarly, a
software company should have controls in place to determine whether capitalized software
development costs will be realized. Exhibit 12.2 identifies examples of other controls over
intangible long-lived assets that clients may design and implement.
12-44
Analytical procedures that would be included as part of planning analytical procedures related to
depreciation expense include analysis of the following relationships, in the light the expectations
developed by the auditor:
• Current depreciation expense as a percentage of the previous year's depreciation expense,
• Fixed assets (by class) as a percentage of previous year's assets. The relative increase in
this percentage can be compared with the relative increase in depreciation expense as a
test of overall reasonableness.
• Depreciation expense (by asset class) as a percentage of assets each year. This ratio can
indicate changes in the age of equipment or changes in depreciation policy, or
computation errors.
• Accumulated depreciation (by class) as a percentage of gross assets each year. This ratio
provides information on the overall reasonableness of the account and may indicate
problems of accounting for fully depreciated equipment.
• Average age of equipment (by class). This ratio provides additional insight on the age of
assets and may be useful in modifying depreciation estimates.
12-45
Ratios and expected relationships that auditors can use when performing planning analytical
procedures include:
• Review and analyze gains/losses on disposals of equipment (gains indicate
depreciation lives are too short, losses indicate the opposite).
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-6
• Perform an overall estimate of depreciation expense.
• Compare capital expenditures with the client’s capital budget, with an expectation that
capital expenditures would be in line with the capital budget.
• Compare depreciable lives used by the client for various asset categories with that of
the industry, with a typical expectation that the client’s depreciable lives would be
consistent with those in the industry. Large differences may indicate earnings
management.
• Compare the asset and related expense account balances in the current period to similar
items in the prior audit and determine whether the amounts appear reasonable in relation
to other information you know about the client, such as changes in operations
Ratios that the auditor should plan to review, after developing independent expectations, include:
• Ratio of depreciation expense to total depreciable long-lived tangible assets. This ratio
should be predictable and comparable over time unless there is a change in depreciation
method or asset lives. The auditor should plan to analyze any unexpected deviations and
assess whether any changes are reasonable.
• Ratio of repairs and maintenance expense to total depreciable long-lived tangible assets.
This ratio may fluctuate because of changes in management’s policies (for example,
maintenance expenses can be postponed without immediate breakdowns or loss of
productivity). The auditor should plan to analyze any unexpected deviation with this
consideration in mind.
• Long-lived assets to total assets
12-46
Panel B of Exhibit 12.3 illustrates the different levels of assurance that the auditor could obtain
from tests of controls and substantive procedures. The reason for the differing approaches is due
to the different levels of risk of material misstatement associated with each of the clients. Panel
B makes the point that because of the higher risk associated with the existence of equipment at
Client B, the auditor will want to design the audit so that more of the assurance is coming from
tests of details. In contrast, the risk associated with the existence of equipment at Client A is
lower and therefore the auditor would be willing to obtain more assurance from tests of controls
and substantive analytics, and less assurance from substantive tests of details. Note that the
relative percentages are judgmental in nature; the examples are simply intended to give you a
sense of how an auditor might select an appropriate mix of procedures.
12-47
For many organizations, long-lived assets involve only a few assets of relatively high value. In
these settings, the time and effort needed to perform tests of controls in order to reduce
substantive testing may exceed the time required to simply perform the substantive tests. Thus,
the most efficient approach would be to use a substantive approach, using test of details, for
testing.
12-6
• Perform an overall estimate of depreciation expense.
• Compare capital expenditures with the client’s capital budget, with an expectation that
capital expenditures would be in line with the capital budget.
• Compare depreciable lives used by the client for various asset categories with that of
the industry, with a typical expectation that the client’s depreciable lives would be
consistent with those in the industry. Large differences may indicate earnings
management.
• Compare the asset and related expense account balances in the current period to similar
items in the prior audit and determine whether the amounts appear reasonable in relation
to other information you know about the client, such as changes in operations
Ratios that the auditor should plan to review, after developing independent expectations, include:
• Ratio of depreciation expense to total depreciable long-lived tangible assets. This ratio
should be predictable and comparable over time unless there is a change in depreciation
method or asset lives. The auditor should plan to analyze any unexpected deviations and
assess whether any changes are reasonable.
• Ratio of repairs and maintenance expense to total depreciable long-lived tangible assets.
This ratio may fluctuate because of changes in management’s policies (for example,
maintenance expenses can be postponed without immediate breakdowns or loss of
productivity). The auditor should plan to analyze any unexpected deviation with this
consideration in mind.
• Long-lived assets to total assets
12-46
Panel B of Exhibit 12.3 illustrates the different levels of assurance that the auditor could obtain
from tests of controls and substantive procedures. The reason for the differing approaches is due
to the different levels of risk of material misstatement associated with each of the clients. Panel
B makes the point that because of the higher risk associated with the existence of equipment at
Client B, the auditor will want to design the audit so that more of the assurance is coming from
tests of details. In contrast, the risk associated with the existence of equipment at Client A is
lower and therefore the auditor would be willing to obtain more assurance from tests of controls
and substantive analytics, and less assurance from substantive tests of details. Note that the
relative percentages are judgmental in nature; the examples are simply intended to give you a
sense of how an auditor might select an appropriate mix of procedures.
12-47
For many organizations, long-lived assets involve only a few assets of relatively high value. In
these settings, the time and effort needed to perform tests of controls in order to reduce
substantive testing may exceed the time required to simply perform the substantive tests. Thus,
the most efficient approach would be to use a substantive approach, using test of details, for
testing.
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-7
12-48
Control Procedure Purpose of Control
Procedure (a)
Impact on Substantive Audit
Procedures (b)
1. Periodic physical
inventory of assets.
Provide reasonable
assurance that records
reflect equipment on-hand
and in use. Relates to
existence and
completeness.
Auditor should expand
procedures either by taking a
sample from the property ledger
and verifying existence or take a
tour of plant and identify idle
equipment for future review (or
both procedures.)
2. Policy to classify
equipment and compute
depreciation.
Provide reasonable
assurance of consistent use
of depreciation methods
based on experience of
client. Relates to valuation.
Auditor would have to review
each equipment life for
consistency and rationale for the
life chosen.
3. Policy on minimum
amounts that are to be
capitalized.
Promote processing
efficiency by expensing
small dollar value items.
There is no particular effect on
the audit except that the
property, plant and equipment
ledger would have substantially
larger items as the smaller dollar
items would have been
expensed.
4. Method for designating
scrap or idle equipment for
disposal.
Provide reasonable
assurance that the records
are updated for changes in
productive life of assets.
Relates to valuation.
Auditor would expand
production facilities tour with
special emphasis on identifying
obsolete or non-productive
assets. The items identified
would be discussed with
management in order to
determine if adjustments are
needed.
5. Differentiate major
renovations from repair
and maintenance.
Provide reasonable
assurance that the proper
accounting since major
renovations may extend
the life of the asset and
should be debited to
accumulated depreciation.
Expand review of repairs and
maintenance expense.
Investigate all large expenditures
to determine if they are more
appropriately classified as
renovations.
6. Self-construction of
assets.
Provide reasonable
assurance of proper
Perform a detailed review of all
self-constructed assets.
12-7
12-48
Control Procedure Purpose of Control
Procedure (a)
Impact on Substantive Audit
Procedures (b)
1. Periodic physical
inventory of assets.
Provide reasonable
assurance that records
reflect equipment on-hand
and in use. Relates to
existence and
completeness.
Auditor should expand
procedures either by taking a
sample from the property ledger
and verifying existence or take a
tour of plant and identify idle
equipment for future review (or
both procedures.)
2. Policy to classify
equipment and compute
depreciation.
Provide reasonable
assurance of consistent use
of depreciation methods
based on experience of
client. Relates to valuation.
Auditor would have to review
each equipment life for
consistency and rationale for the
life chosen.
3. Policy on minimum
amounts that are to be
capitalized.
Promote processing
efficiency by expensing
small dollar value items.
There is no particular effect on
the audit except that the
property, plant and equipment
ledger would have substantially
larger items as the smaller dollar
items would have been
expensed.
4. Method for designating
scrap or idle equipment for
disposal.
Provide reasonable
assurance that the records
are updated for changes in
productive life of assets.
Relates to valuation.
Auditor would expand
production facilities tour with
special emphasis on identifying
obsolete or non-productive
assets. The items identified
would be discussed with
management in order to
determine if adjustments are
needed.
5. Differentiate major
renovations from repair
and maintenance.
Provide reasonable
assurance that the proper
accounting since major
renovations may extend
the life of the asset and
should be debited to
accumulated depreciation.
Expand review of repairs and
maintenance expense.
Investigate all large expenditures
to determine if they are more
appropriately classified as
renovations.
6. Self-construction of
assets.
Provide reasonable
assurance of proper
Perform a detailed review of all
self-constructed assets.
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12-8
Control Procedure Purpose of Control
Procedure (a)
Impact on Substantive Audit
Procedures (b)
accounting for self-
constructed assets.
7. Systematic review for
asset impairment.
Provide reasonable
assurance of proper
accounting for asset
impairment (valuation
issues). Company
performing the review on a
consistent basis is a strong
control because it
eliminates many of the
"big bath" write-offs.
Auditor would have to review
asset productivity each year and
make inquiries of client of the
accounting for impaired assets.
Auditor would be more alert to
declining productivity indicators
or changes in product mix that
might affect asset values.
8. Management
periodically reviews
disposals for potential
impact on changing asset
lives for depreciation
purposes.
Provide reasonable
assurance of asset
valuation.
Auditor should review asset
disposals for potential impact on
choice of economic lives for
assets.
12-49
Test of controls over tangible long-lived assets could include:
• Examine documentation corroborating that a tangible long-lived asset budget is prepared
and used.
• Examine relevant documentation for management's approval process of the tangible long-
lived asset budget.
• Examine a sample of tangible long-lived asset requisition forms for management's
approval.
• Inspect copies of the vouchers used to document departmental request for sale,
retirement, or scrapping of tangible long-lived assets for management's approval.
• Test depreciation shown in the general ledger to the amounts shown in the tangible long-
lived asset ledger. (This might be performed as a dual purpose test.)
• Review or recompute a sample of depreciation calculations.
• Agree the posting of depreciation expense to the general ledger.
• Inspect the tangible long-lived asset ledger for adequate detail to support the tangible
long-lived asset accounts.
• Verify that the tangible long-lived asset ledger is periodically balanced to the general
ledger.
• Verify accuracy of calculations on a sample of tangible long-lived asset requisition
forms.
12-8
Control Procedure Purpose of Control
Procedure (a)
Impact on Substantive Audit
Procedures (b)
accounting for self-
constructed assets.
7. Systematic review for
asset impairment.
Provide reasonable
assurance of proper
accounting for asset
impairment (valuation
issues). Company
performing the review on a
consistent basis is a strong
control because it
eliminates many of the
"big bath" write-offs.
Auditor would have to review
asset productivity each year and
make inquiries of client of the
accounting for impaired assets.
Auditor would be more alert to
declining productivity indicators
or changes in product mix that
might affect asset values.
8. Management
periodically reviews
disposals for potential
impact on changing asset
lives for depreciation
purposes.
Provide reasonable
assurance of asset
valuation.
Auditor should review asset
disposals for potential impact on
choice of economic lives for
assets.
12-49
Test of controls over tangible long-lived assets could include:
• Examine documentation corroborating that a tangible long-lived asset budget is prepared
and used.
• Examine relevant documentation for management's approval process of the tangible long-
lived asset budget.
• Examine a sample of tangible long-lived asset requisition forms for management's
approval.
• Inspect copies of the vouchers used to document departmental request for sale,
retirement, or scrapping of tangible long-lived assets for management's approval.
• Test depreciation shown in the general ledger to the amounts shown in the tangible long-
lived asset ledger. (This might be performed as a dual purpose test.)
• Review or recompute a sample of depreciation calculations.
• Agree the posting of depreciation expense to the general ledger.
• Inspect the tangible long-lived asset ledger for adequate detail to support the tangible
long-lived asset accounts.
• Verify that the tangible long-lived asset ledger is periodically balanced to the general
ledger.
• Verify accuracy of calculations on a sample of tangible long-lived asset requisition
forms.
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12-9
• Check for the existence of a written policy which establishes whether a budget request is
to be considered a capital expenditure or a routine maintenance expenditure.
• Confirm the existence of approved vouchers for entries which remove assets from the
tangible long-lived asset ledger.
• Inspect documentation of tangible long-lived asset requisition forms for authenticity.
• Test a sample of maintenance expenditures to evaluate compliance with the written
policy which establishes whether an item is to be considered a capital expenditure or a
routine maintenance expenditure.
• Evaluate the effectiveness and appropriateness of the written policy used to distinguish
capital expenditures from maintenance expenditures.
• Compare costs and prices on a sample of tangible long-lived asset requisition forms to
established list prices to determine reasonableness.
• Compare sale or scrap prices on a sample of vouchers used to document departmental
requests for sale, retirement, or scrapping of tangible long-lived assets to established list
prices to determine reasonableness.
• Review tangible long-lived asset budget reports and note management's explanation of
any significant variances.
• Scan the tangible long-lived asset ledger for unusually large or small items.
• Through review of relevant documentation and inquiry of appropriate personnel
determine that tangible long-lived asset records are maintained by persons other than
those who are responsible for custody and use of the assets.
• Agree the identification numbers of a sample of fixed assets to those shown in the
tangible long-lived asset ledger.
• Through review of relevant documentation and inquiry of appropriate personnel, verify
that periodic physical inventories of tangible long-lived assets are taken for purposes of
reconciliation to the tangible long-lived asset ledger as well as appraisal for insurance
purposes.
• Through review of relevant documentation and inquiry of appropriate personnel,
substantiate that periodic physical inventories of tangible long-lived assets are taken
under the supervision of employees who are not responsible for the custody of record
keeping for the tangible long-lived assets.
• Through review of relevant documentation and inquiry of appropriate personnel,
investigate whether significant discrepancies between the tangible long-lived asset ledger
and physical inventories are reported to management.
12-50
CONTROL POSSIBLE TESTS OF CONTROLS
Management authorizations are required for
intangible asset transactions.
For selected intangible asset transactions
inquire of management as to the authorization
process and review documentation of the
appropriate authorizations.
Documentation regarding intangible assets
should be maintained and such documentation
should include:
For selected intangible assets, review
documentation and assess reasonableness of
management estimates
12-9
• Check for the existence of a written policy which establishes whether a budget request is
to be considered a capital expenditure or a routine maintenance expenditure.
• Confirm the existence of approved vouchers for entries which remove assets from the
tangible long-lived asset ledger.
• Inspect documentation of tangible long-lived asset requisition forms for authenticity.
• Test a sample of maintenance expenditures to evaluate compliance with the written
policy which establishes whether an item is to be considered a capital expenditure or a
routine maintenance expenditure.
• Evaluate the effectiveness and appropriateness of the written policy used to distinguish
capital expenditures from maintenance expenditures.
• Compare costs and prices on a sample of tangible long-lived asset requisition forms to
established list prices to determine reasonableness.
• Compare sale or scrap prices on a sample of vouchers used to document departmental
requests for sale, retirement, or scrapping of tangible long-lived assets to established list
prices to determine reasonableness.
• Review tangible long-lived asset budget reports and note management's explanation of
any significant variances.
• Scan the tangible long-lived asset ledger for unusually large or small items.
• Through review of relevant documentation and inquiry of appropriate personnel
determine that tangible long-lived asset records are maintained by persons other than
those who are responsible for custody and use of the assets.
• Agree the identification numbers of a sample of fixed assets to those shown in the
tangible long-lived asset ledger.
• Through review of relevant documentation and inquiry of appropriate personnel, verify
that periodic physical inventories of tangible long-lived assets are taken for purposes of
reconciliation to the tangible long-lived asset ledger as well as appraisal for insurance
purposes.
• Through review of relevant documentation and inquiry of appropriate personnel,
substantiate that periodic physical inventories of tangible long-lived assets are taken
under the supervision of employees who are not responsible for the custody of record
keeping for the tangible long-lived assets.
• Through review of relevant documentation and inquiry of appropriate personnel,
investigate whether significant discrepancies between the tangible long-lived asset ledger
and physical inventories are reported to management.
12-50
CONTROL POSSIBLE TESTS OF CONTROLS
Management authorizations are required for
intangible asset transactions.
For selected intangible asset transactions
inquire of management as to the authorization
process and review documentation of the
appropriate authorizations.
Documentation regarding intangible assets
should be maintained and such documentation
should include:
For selected intangible assets, review
documentation and assess reasonableness of
management estimates
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12-10
o Manner of acquisition (e.g.,
purchased, developed internally),
o Basis for the capitalized amount,
o Expected period of benefit, and
amortization method.
Amortization periods and calculations should
be approved and periodically reviewed by
appropriate personnel.
For selected items, inquire of management
regarding this process, review documentation
supporting the process, and recompute
calculations.
12-51
• To detect fictitious assets, the auditor should have traced recent recorded acquisitions of
long-lived asset accounts to original source documents; doing so would have enabled the
auditor to realize that such documents did not exist.
• For improper depreciation, the auditor should have compared depreciation expense over a
period of time, adjusting for the volume of business and the number of trucks used. The
decrease in depreciation per truck should have led to more detailed investigation,
including tests of depreciation on each truck.
• For the impairment issue, the auditor should have compared current earnings with future
expected earnings that were predicted when the goodwill was initially recorded. A
dramatic decrease in current earnings signals the need for an impairment adjustment. As
discussed in a later chapter, there is a formalized approach to be used in determining
goodwill impairment
• For the impaired assets, the auditor should have noted (a) the relative age of the assets
(net book value has decreased), (b) idle equipment during a tour of the factory, and (c)
should have traced apparently idle assets to the books.
• For the assets overvalued at acquisition, the auditor should have determined if the
company had used a reputable and certified independent appraiser. If the auditor had
doubts, he or she should have hired an appraiser (auditor expert/specialist) to form an
independent opinion.
12-52
Compute the average balance: ($380,500 + $438,900) / 2 = $409,700
Adjust for the salvage value: $409,700 * .9 = $368,730
Compute the annual depreciation expense: $368,730 / 6 = $61,455.
Once the auditor has developed an expectation of the account balance, the auditor will compare
that expectation with the amount recorded by the client. If the difference between the two
amounts is less than the threshold (based on level of materiality) set by the auditor, the auditor
would conclude that the recorded depreciation expense is reasonable. Although the problem did
not provide details on the auditor’s threshold, it is reasonable to believe that the difference
between the auditor’s expectation and the client’s recorded amount in this problem would be
below that auditor’s threshold. Thus, the auditor would likely conclude that the recorded
12-10
o Manner of acquisition (e.g.,
purchased, developed internally),
o Basis for the capitalized amount,
o Expected period of benefit, and
amortization method.
Amortization periods and calculations should
be approved and periodically reviewed by
appropriate personnel.
For selected items, inquire of management
regarding this process, review documentation
supporting the process, and recompute
calculations.
12-51
• To detect fictitious assets, the auditor should have traced recent recorded acquisitions of
long-lived asset accounts to original source documents; doing so would have enabled the
auditor to realize that such documents did not exist.
• For improper depreciation, the auditor should have compared depreciation expense over a
period of time, adjusting for the volume of business and the number of trucks used. The
decrease in depreciation per truck should have led to more detailed investigation,
including tests of depreciation on each truck.
• For the impairment issue, the auditor should have compared current earnings with future
expected earnings that were predicted when the goodwill was initially recorded. A
dramatic decrease in current earnings signals the need for an impairment adjustment. As
discussed in a later chapter, there is a formalized approach to be used in determining
goodwill impairment
• For the impaired assets, the auditor should have noted (a) the relative age of the assets
(net book value has decreased), (b) idle equipment during a tour of the factory, and (c)
should have traced apparently idle assets to the books.
• For the assets overvalued at acquisition, the auditor should have determined if the
company had used a reputable and certified independent appraiser. If the auditor had
doubts, he or she should have hired an appraiser (auditor expert/specialist) to form an
independent opinion.
12-52
Compute the average balance: ($380,500 + $438,900) / 2 = $409,700
Adjust for the salvage value: $409,700 * .9 = $368,730
Compute the annual depreciation expense: $368,730 / 6 = $61,455.
Once the auditor has developed an expectation of the account balance, the auditor will compare
that expectation with the amount recorded by the client. If the difference between the two
amounts is less than the threshold (based on level of materiality) set by the auditor, the auditor
would conclude that the recorded depreciation expense is reasonable. Although the problem did
not provide details on the auditor’s threshold, it is reasonable to believe that the difference
between the auditor’s expectation and the client’s recorded amount in this problem would be
below that auditor’s threshold. Thus, the auditor would likely conclude that the recorded
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-11
depreciation expense of $60,500 appears reasonable, given the auditor’s expectation of $61,455.
Given the results of this substantive analytical procedure, the auditor will likely not need to
perform any additional substantive tests of details.
12-53
The audit approaches applicable to identifying and determining the proper accounting of fully
depreciated or idle facilities would include:
• The auditor should tour the client facilities and make inquiries concerning idle
equipment. The auditor should note all idle equipment to be subsequently traced to the
property ledger. Discussions with management about these issues will also be helpful.
• GAS could be used to develop a schedule of fully depreciated assets. A sample could be
taken and the auditor could attempt to physically observe the asset and determine whether
it is in production and whether a scrap value is appropriate.
12-54
The client has a policy that apparently has been used for a number of years. Assignment of assets
to classes for depreciation purposes is common and represents an expedient method of dealing
with depreciation issues. The auditor can determine the reasonableness of the classification
schemes by:
• Reviewing previous data on the asset's productive life (within each category)
• Reviewing IRS guidelines for classification and reasonableness in comparison with the
company's categories and life guidelines
• Noting significant gains/losses on disposal (suggesting potentially inappropriate asset
lives).
12-55
The general concept of valuing impaired assets consists of two major approaches:
• Estimating the future economic benefits to be derived from the asset. The auditor would
evaluate management’s assumptions and estimates for reasonableness.
• Obtaining an independent appraisal of current value. The auditor could either assess the
competence and independence of the appraiser hired by management and the
reasonableness of the assumptions used and/or the auditor could obtain an independent
appraisal of the value of the asset.
12-56
The auditor must make sure the appraisal is reasonable. The auditor should consider the
qualifications and certification of the appraiser and appropriateness of the assumptions used by
12-11
depreciation expense of $60,500 appears reasonable, given the auditor’s expectation of $61,455.
Given the results of this substantive analytical procedure, the auditor will likely not need to
perform any additional substantive tests of details.
12-53
The audit approaches applicable to identifying and determining the proper accounting of fully
depreciated or idle facilities would include:
• The auditor should tour the client facilities and make inquiries concerning idle
equipment. The auditor should note all idle equipment to be subsequently traced to the
property ledger. Discussions with management about these issues will also be helpful.
• GAS could be used to develop a schedule of fully depreciated assets. A sample could be
taken and the auditor could attempt to physically observe the asset and determine whether
it is in production and whether a scrap value is appropriate.
12-54
The client has a policy that apparently has been used for a number of years. Assignment of assets
to classes for depreciation purposes is common and represents an expedient method of dealing
with depreciation issues. The auditor can determine the reasonableness of the classification
schemes by:
• Reviewing previous data on the asset's productive life (within each category)
• Reviewing IRS guidelines for classification and reasonableness in comparison with the
company's categories and life guidelines
• Noting significant gains/losses on disposal (suggesting potentially inappropriate asset
lives).
12-55
The general concept of valuing impaired assets consists of two major approaches:
• Estimating the future economic benefits to be derived from the asset. The auditor would
evaluate management’s assumptions and estimates for reasonableness.
• Obtaining an independent appraisal of current value. The auditor could either assess the
competence and independence of the appraiser hired by management and the
reasonableness of the assumptions used and/or the auditor could obtain an independent
appraisal of the value of the asset.
12-56
The auditor must make sure the appraisal is reasonable. The auditor should consider the
qualifications and certification of the appraiser and appropriateness of the assumptions used by
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12-12
the appraiser. The auditor may also need to use an auditor specialist/expert to assist with these
audit procedures.
12-57
General substantive procedures for leases include:
• Obtain copies of lease agreements, read the agreements, and develop a schedule of lease
expenditures.
• Review the lease expense account, select entries to the account, and determine if there are
entries that are not covered by the leases obtained from the client. Review to determine if
the expenses are properly accounted for.
• Review the relevant criteria from FASB ASC to determine which leases meet the
requirement of capital leases.
• For all capital leases, determine that the assets and lease obligations are recorded at their
present value. Determine the economic life of the asset. Calculate amortization expense
and interest expenses, and determine any adjustments to correct the financial statements.
• Develop a schedule of all future lease obligations or test the client’s schedule by
reference to underlying lease agreements to determine that the schedule is correct.
• Review the client’s disclosure of lease obligations to determine that it is in accordance
with GAAP.
12-58
Items 1 through 6 could have been found in the following way:
1. The company's policies for depreciating equipment are available from several sources:
• The prior-year's audit working papers and permanent file.
• Footnote disclosure in the annual report and SEC Form 10-K.
• Company procedures manual.
• Detailed fixed asset records.
• Inquiry of relevant client personnel.
2. The ten-year lease contract would be found when supporting data for current year's
equipment additions were examined. Also, it may be found by a review of company lease and
contract files.
3. The building wing addition would be apparent by the addition to buildings during the
year. The use of the low construction bid amount would be found when support for the addition
was examined. When it was determined that this inappropriate method was followed, the actual
costs were determined by reference to construction work orders and supporting data. The wing
was also physically observed by the auditor.
4. The paving and fencing was discovered when support was examined for the addition to
land. These costs should be charged to Land Improvements and depreciated.
12-12
the appraiser. The auditor may also need to use an auditor specialist/expert to assist with these
audit procedures.
12-57
General substantive procedures for leases include:
• Obtain copies of lease agreements, read the agreements, and develop a schedule of lease
expenditures.
• Review the lease expense account, select entries to the account, and determine if there are
entries that are not covered by the leases obtained from the client. Review to determine if
the expenses are properly accounted for.
• Review the relevant criteria from FASB ASC to determine which leases meet the
requirement of capital leases.
• For all capital leases, determine that the assets and lease obligations are recorded at their
present value. Determine the economic life of the asset. Calculate amortization expense
and interest expenses, and determine any adjustments to correct the financial statements.
• Develop a schedule of all future lease obligations or test the client’s schedule by
reference to underlying lease agreements to determine that the schedule is correct.
• Review the client’s disclosure of lease obligations to determine that it is in accordance
with GAAP.
12-58
Items 1 through 6 could have been found in the following way:
1. The company's policies for depreciating equipment are available from several sources:
• The prior-year's audit working papers and permanent file.
• Footnote disclosure in the annual report and SEC Form 10-K.
• Company procedures manual.
• Detailed fixed asset records.
• Inquiry of relevant client personnel.
2. The ten-year lease contract would be found when supporting data for current year's
equipment additions were examined. Also, it may be found by a review of company lease and
contract files.
3. The building wing addition would be apparent by the addition to buildings during the
year. The use of the low construction bid amount would be found when support for the addition
was examined. When it was determined that this inappropriate method was followed, the actual
costs were determined by reference to construction work orders and supporting data. The wing
was also physically observed by the auditor.
4. The paving and fencing was discovered when support was examined for the addition to
land. These costs should be charged to Land Improvements and depreciated.
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12-13
5. The details of the retirement transactions were determined by examining the sales
agreement, cash receipts documentation, and related detailed fixed asset record. This
examination would be instigated by the recording of the retirement in the machinery account or
the review of cash receipts records.
6. The auditor would become aware of a new plant in several ways:
• Volume would increase.
• Account details such as cash, inventory, prepaid expenses, and payroll would be
attributed to the new location.
• The transaction may be indicated in documents such as the minutes of the board, press
releases, and reports to the stockholders.
• Property tax and insurance bills examined show the new plant.
• Inquiry of appropriate client personnel.
One or more of these factors would lead the auditor to investigate the reasons and
circumstances involved. Documents from the city and appraisals would be examined to
determine the details involved.
12-59
a. Impairment of assets refers to long-lived tangible assets and certain identifiable
intangibles to be held and used by an entity for which events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. In performing the review
for recoverability, the entity should estimate the future cash flows expected to result from the use
of the asset and its eventual disposition. If the sum of the expected future cash flows
(undiscounted and without interest charges) is less than the carrying amount of the asset, an
impairment loss is recognized. Otherwise, an impairment loss is not recognized. Measurement of
an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold
and use should be based on the fair value of the asset.
b. Management’s motivation will depend on the specific facts and circumstances. In some
settings, management may follow the so-called big bath theory and take very large write-offs
when any write-off occurs. The rationale for this approach is that the market seems to be
forgiving, especially if there is a change in management and the new management can blame the
problems on the previous management. If the write-off is large, then it decreases the amount of
assets that might be charged against earnings in the future. In some settings, the investment
public is skeptical of the large write-offs and has recognized such write-offs as a symbol of
management failure. Thus, managers will resist taking any write-offs unless there is compelling
evidence that there has been impairment in assets.
12-13
5. The details of the retirement transactions were determined by examining the sales
agreement, cash receipts documentation, and related detailed fixed asset record. This
examination would be instigated by the recording of the retirement in the machinery account or
the review of cash receipts records.
6. The auditor would become aware of a new plant in several ways:
• Volume would increase.
• Account details such as cash, inventory, prepaid expenses, and payroll would be
attributed to the new location.
• The transaction may be indicated in documents such as the minutes of the board, press
releases, and reports to the stockholders.
• Property tax and insurance bills examined show the new plant.
• Inquiry of appropriate client personnel.
One or more of these factors would lead the auditor to investigate the reasons and
circumstances involved. Documents from the city and appraisals would be examined to
determine the details involved.
12-59
a. Impairment of assets refers to long-lived tangible assets and certain identifiable
intangibles to be held and used by an entity for which events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. In performing the review
for recoverability, the entity should estimate the future cash flows expected to result from the use
of the asset and its eventual disposition. If the sum of the expected future cash flows
(undiscounted and without interest charges) is less than the carrying amount of the asset, an
impairment loss is recognized. Otherwise, an impairment loss is not recognized. Measurement of
an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold
and use should be based on the fair value of the asset.
b. Management’s motivation will depend on the specific facts and circumstances. In some
settings, management may follow the so-called big bath theory and take very large write-offs
when any write-off occurs. The rationale for this approach is that the market seems to be
forgiving, especially if there is a change in management and the new management can blame the
problems on the previous management. If the write-off is large, then it decreases the amount of
assets that might be charged against earnings in the future. In some settings, the investment
public is skeptical of the large write-offs and has recognized such write-offs as a symbol of
management failure. Thus, managers will resist taking any write-offs unless there is compelling
evidence that there has been impairment in assets.
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12-14
However, it is important to recognize that management will want to understate expenses, and
thus overstate income, and so will want to understate the write-off. The auditor has to be aware
of management’s incentives when assessing the nature and type of potential misstatements.
c.
Step 1. Identify the ethical issue. The ethical issue is that the auditor believes that her estimate is
correct, and knows that it is materially lower than management’s estimate of the impairment.
Allowing the client to record its estimate may keep the client happy, but will result in financial
statements that are misleading.
Step 2. Determine who are the affected parties and identify their rights. There are various
affected parties:
• shareholders, who have a right to accurate financial information
• the audit committee and board, who have a right to know that the auditor and management
are having a material disagreement
• management, who has a right to uphold their own valid, defensible professional opinions
• the auditor and audit firm, who have a right to exercise their own professional judgment and
to minimize potential litigation against themselves
• tax authorities, who have a right to expect that management will make tax deductions that are
reasonable and appropriate
Step 3. Determine the most important rights. The most important rights are likely those of
shareholders, followed by the audit committee and board as major players in the corporate
governance of the company. The tax authorities represent society in general, so their rights are
also quite important.
Step 4. Develop alternative courses of action. The auditor could pursue various courses of action:
a. Try again to convince management that the auditor’s estimates are
superior.
b. Alert the audit committee of the disagreement and let them help to resolve
it.
c. Threaten management with a qualified audit opinion if they refuse to
acquiesce to the auditor’s preference.
d. Resign from the engagement.
Step 5. Determine the likely consequences of each proposed course of action.
a. Trying to convince management may or may not work. If it does work, then
the situation is resolved. If it does not work, the relationship between the
auditor and management will likely become even more strained.
b. Alerting the audit committee is required by professional standards. While it
may annoy management, the auditor can fall back on the requirement to
discuss such issues with the audit committee.
12-14
However, it is important to recognize that management will want to understate expenses, and
thus overstate income, and so will want to understate the write-off. The auditor has to be aware
of management’s incentives when assessing the nature and type of potential misstatements.
c.
Step 1. Identify the ethical issue. The ethical issue is that the auditor believes that her estimate is
correct, and knows that it is materially lower than management’s estimate of the impairment.
Allowing the client to record its estimate may keep the client happy, but will result in financial
statements that are misleading.
Step 2. Determine who are the affected parties and identify their rights. There are various
affected parties:
• shareholders, who have a right to accurate financial information
• the audit committee and board, who have a right to know that the auditor and management
are having a material disagreement
• management, who has a right to uphold their own valid, defensible professional opinions
• the auditor and audit firm, who have a right to exercise their own professional judgment and
to minimize potential litigation against themselves
• tax authorities, who have a right to expect that management will make tax deductions that are
reasonable and appropriate
Step 3. Determine the most important rights. The most important rights are likely those of
shareholders, followed by the audit committee and board as major players in the corporate
governance of the company. The tax authorities represent society in general, so their rights are
also quite important.
Step 4. Develop alternative courses of action. The auditor could pursue various courses of action:
a. Try again to convince management that the auditor’s estimates are
superior.
b. Alert the audit committee of the disagreement and let them help to resolve
it.
c. Threaten management with a qualified audit opinion if they refuse to
acquiesce to the auditor’s preference.
d. Resign from the engagement.
Step 5. Determine the likely consequences of each proposed course of action.
a. Trying to convince management may or may not work. If it does work, then
the situation is resolved. If it does not work, the relationship between the
auditor and management will likely become even more strained.
b. Alerting the audit committee is required by professional standards. While it
may annoy management, the auditor can fall back on the requirement to
discuss such issues with the audit committee.
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-15
c. Threatening management will obviously strain the relationship with the
auditor, but it may be successful in getting management to see the auditor’s
point of view.
d. Resigning is the last resort as it is a fairly extreme measure, and will result in
public disclosure of the disagreement for the company, and loss of revenue for
the audit firm.
Step 6. Assess the possible consequences, including an estimation of the greatest good for the
greatest number. The auditor is required via professional standards to alert the audit committee,
and doing so will likely enable the auditor to (a) re-think their estimate if the audit committee
convincingly challenges their calculations, or (b) use the interaction to convince management to
use the correct valuation in the impairment. Ultimately, the process of interacting with the audit
committee and management will enable all parties to determine the most appropriate impairment
calculation. The revelation of that amount to shareholders and tax authorities will result in the
greatest good for the greatest number.
Step 7. Decide on the appropriate course of action. The auditor should first try to convince
management to change the estimate, and even if they succeed in doing so the auditor must alert
the audit committee to the situation.
12-60
a. The main difficulty that the auditor faces in determining whether the charges are
reasonable is to understand management’s estimation procedures and to decide if they are
reasonable. The auditor will have to understand the following types of decisions:
• Which third party offers were used in the calculations? How did management choose
which offers to use if there were multiple offers?
• What is the appropriate discount rate for the discounted future cash flow calculations?
• Is it appropriate to completely write off the Falkirk, Scotland assets? Or is management
possibly setting up a cookie jar reserve by doing so?
b. The consequences of the auditor’s decisions are associated with providing reasonable
assurance that no fixed assets are inappropriately over-valued on the balance sheet (with
resulting under-expensing of impairment charges on the income statement) or under-valued on
the balance sheet (with resulting over-expensing of impairment charges on the income
statement).
c. The risks are those associated with inaccurate financial reporting, particularly if the
impairment charges are material to the client’s financial statements. The uncertainties involve the
estimates, for example, is a 7% discount rate correct, or should it be 5%?
d. The auditor can gather various types of evidence including:
• Documentation of management’s estimation process and assumptions
• Documentation that includes third-party offers and negotiations
• Confirmations with third parties
12-15
c. Threatening management will obviously strain the relationship with the
auditor, but it may be successful in getting management to see the auditor’s
point of view.
d. Resigning is the last resort as it is a fairly extreme measure, and will result in
public disclosure of the disagreement for the company, and loss of revenue for
the audit firm.
Step 6. Assess the possible consequences, including an estimation of the greatest good for the
greatest number. The auditor is required via professional standards to alert the audit committee,
and doing so will likely enable the auditor to (a) re-think their estimate if the audit committee
convincingly challenges their calculations, or (b) use the interaction to convince management to
use the correct valuation in the impairment. Ultimately, the process of interacting with the audit
committee and management will enable all parties to determine the most appropriate impairment
calculation. The revelation of that amount to shareholders and tax authorities will result in the
greatest good for the greatest number.
Step 7. Decide on the appropriate course of action. The auditor should first try to convince
management to change the estimate, and even if they succeed in doing so the auditor must alert
the audit committee to the situation.
12-60
a. The main difficulty that the auditor faces in determining whether the charges are
reasonable is to understand management’s estimation procedures and to decide if they are
reasonable. The auditor will have to understand the following types of decisions:
• Which third party offers were used in the calculations? How did management choose
which offers to use if there were multiple offers?
• What is the appropriate discount rate for the discounted future cash flow calculations?
• Is it appropriate to completely write off the Falkirk, Scotland assets? Or is management
possibly setting up a cookie jar reserve by doing so?
b. The consequences of the auditor’s decisions are associated with providing reasonable
assurance that no fixed assets are inappropriately over-valued on the balance sheet (with
resulting under-expensing of impairment charges on the income statement) or under-valued on
the balance sheet (with resulting over-expensing of impairment charges on the income
statement).
c. The risks are those associated with inaccurate financial reporting, particularly if the
impairment charges are material to the client’s financial statements. The uncertainties involve the
estimates, for example, is a 7% discount rate correct, or should it be 5%?
d. The auditor can gather various types of evidence including:
• Documentation of management’s estimation process and assumptions
• Documentation that includes third-party offers and negotiations
• Confirmations with third parties
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-16
• Comparisons of fixed asset values with competitors
• Understanding and documenting management’s potential motivations for under- or over-
expensing the impairment charges
• Obtaining current market values of assets.
Fraud Focus: Contemporary and Historical Cases
12-61
a. IRG’s lease accounts and fixed asset accounts (including related deprecation charges)
were misstated.
b. While the textbook feature does not provide information specifically related to
management motivation and does not suggest that management acted fraudulently, students will
likely note that the company recently went public and may have intentionally misstated the
financial statements so that the public offering would be more successful. The motivation,
coupled with opportunity due to weak internal controls, is often highlighted by students.
c. Typical controls that affect multiple assertions for long-lived assets include:
• Formal budgeting process with appropriate follow-up variance analysis
• Written policies for acquisition and disposals of long-lived assets, including required
approvals
• Limited physical access to assets, where appropriate
• Periodic comparison of physical assets to subsidiary records
• Periodic reconciliations of subsidiary records with the general ledger
Further, controls should be in place to:
• Identify existing assets, inventory them, and reconcile the physical asset inventory with
the property ledger on a periodic basis (existence).
• Provide reasonable assurance that all purchases are authorized and properly valued
(valuation).
• Appropriately classify new equipment according to its expected use and estimate of
useful life (valuation).
• Periodically reassess the appropriateness of depreciation categories (valuation).
• Identify obsolete or scrapped equipment and write the equipment down to scrap value
(valuation).
• Review management strategy and systematically assess the impairment of assets
(valuation).
With respect to the lease accounts, the company should have policies and procedures requiring
review all of leases by a qualified lease accountant to provide reasonable assurance over proper
recording of those transactions.
d. The auditors should have gained an understanding of the client’s internal controls over
these long-lived assets. If the controls were not well designed (or determined not to be operating
12-16
• Comparisons of fixed asset values with competitors
• Understanding and documenting management’s potential motivations for under- or over-
expensing the impairment charges
• Obtaining current market values of assets.
Fraud Focus: Contemporary and Historical Cases
12-61
a. IRG’s lease accounts and fixed asset accounts (including related deprecation charges)
were misstated.
b. While the textbook feature does not provide information specifically related to
management motivation and does not suggest that management acted fraudulently, students will
likely note that the company recently went public and may have intentionally misstated the
financial statements so that the public offering would be more successful. The motivation,
coupled with opportunity due to weak internal controls, is often highlighted by students.
c. Typical controls that affect multiple assertions for long-lived assets include:
• Formal budgeting process with appropriate follow-up variance analysis
• Written policies for acquisition and disposals of long-lived assets, including required
approvals
• Limited physical access to assets, where appropriate
• Periodic comparison of physical assets to subsidiary records
• Periodic reconciliations of subsidiary records with the general ledger
Further, controls should be in place to:
• Identify existing assets, inventory them, and reconcile the physical asset inventory with
the property ledger on a periodic basis (existence).
• Provide reasonable assurance that all purchases are authorized and properly valued
(valuation).
• Appropriately classify new equipment according to its expected use and estimate of
useful life (valuation).
• Periodically reassess the appropriateness of depreciation categories (valuation).
• Identify obsolete or scrapped equipment and write the equipment down to scrap value
(valuation).
• Review management strategy and systematically assess the impairment of assets
(valuation).
With respect to the lease accounts, the company should have policies and procedures requiring
review all of leases by a qualified lease accountant to provide reasonable assurance over proper
recording of those transactions.
d. The auditors should have gained an understanding of the client’s internal controls over
these long-lived assets. If the controls were not well designed (or determined not to be operating
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-17
effectively), the auditors should have increased the assurance they needed regarding whether the
asset accounts were materially misstated. For the lease audit, the auditors could perform the
following:
• Obtain copies of lease agreements, read the agreements, and develop a schedule of lease
expenditures.
• Review the lease expense account, select entries to the account, and determine if there are
entries that are not covered by the leases obtained from the client. Review to determine if
the expenses are properly accounted for.
• Review the relevant criteria from FASB ASC to determine which leases meet the
requirement of capital leases.
• For all capital leases, determine that the assets and lease obligations are recorded at their
present value. Determine the economic life of the asset. Calculate amortization expense
and interest expenses, and determine any adjustments to correct the financial statements.
• Develop a schedule of all future lease obligations or test the client’s schedule by
reference to underlying lease agreements to determine that the schedule is correct.
• Review the client’s disclosure of lease obligations to determine that it is in accordance
with GAAP.
As for the tangible long-lived assets, a great deal of this chapter is focused on appropriate
substantive procedures for both the asset and expense accounts. Further, Exhibit 12-4 outlines
possible procedures that the auditor could have performed.
12-62
a. Yes, it would be highly unusual for debits to fixed assets to come from adjusting journal
entries. Most debits to fixed assets should come from purchases of the assets and should be
evidenced by invoices and contracts. The auditor should view significant amounts of debits to
fixed asset as high risk and should investigate all of the entries if the aggregate amount could be
significant or material.
b. No, entries to depreciation expense and accumulated depreciation should normally come
from adjusting journal entries. However, the journal entries should come from an automated
computer program. Thus, the auditor should trace the summary entries back to the detail
computation for specific items.
c. An explanation of “Capitalization of line capacity per CFO, amounts were originally
incorrectly recorded as an expense” is a highly unusual description of a transaction. The auditor
should be highly skeptical because it does not appear to be supported by outside, objective
evidence. The client claims it is misclassified as an expense. The auditor should seek the
following evidence:
• Ask the client to examine the original invoice, contract, and other information associated
with the original payment for the goods, services, or fixed asset.
• The auditor should examine the invoice to determine the nature of the purchase.
12-17
effectively), the auditors should have increased the assurance they needed regarding whether the
asset accounts were materially misstated. For the lease audit, the auditors could perform the
following:
• Obtain copies of lease agreements, read the agreements, and develop a schedule of lease
expenditures.
• Review the lease expense account, select entries to the account, and determine if there are
entries that are not covered by the leases obtained from the client. Review to determine if
the expenses are properly accounted for.
• Review the relevant criteria from FASB ASC to determine which leases meet the
requirement of capital leases.
• For all capital leases, determine that the assets and lease obligations are recorded at their
present value. Determine the economic life of the asset. Calculate amortization expense
and interest expenses, and determine any adjustments to correct the financial statements.
• Develop a schedule of all future lease obligations or test the client’s schedule by
reference to underlying lease agreements to determine that the schedule is correct.
• Review the client’s disclosure of lease obligations to determine that it is in accordance
with GAAP.
As for the tangible long-lived assets, a great deal of this chapter is focused on appropriate
substantive procedures for both the asset and expense accounts. Further, Exhibit 12-4 outlines
possible procedures that the auditor could have performed.
12-62
a. Yes, it would be highly unusual for debits to fixed assets to come from adjusting journal
entries. Most debits to fixed assets should come from purchases of the assets and should be
evidenced by invoices and contracts. The auditor should view significant amounts of debits to
fixed asset as high risk and should investigate all of the entries if the aggregate amount could be
significant or material.
b. No, entries to depreciation expense and accumulated depreciation should normally come
from adjusting journal entries. However, the journal entries should come from an automated
computer program. Thus, the auditor should trace the summary entries back to the detail
computation for specific items.
c. An explanation of “Capitalization of line capacity per CFO, amounts were originally
incorrectly recorded as an expense” is a highly unusual description of a transaction. The auditor
should be highly skeptical because it does not appear to be supported by outside, objective
evidence. The client claims it is misclassified as an expense. The auditor should seek the
following evidence:
• Ask the client to examine the original invoice, contract, and other information associated
with the original payment for the goods, services, or fixed asset.
• The auditor should examine the invoice to determine the nature of the purchase.
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-18
• The auditor should determine that the document that is examined was not used to support
other purchases, that is, the auditor should be suspicious of the information because it is
all obtained internally. The auditor should be concerned that one invoice might serve as
support for this journal entry and another purchase.
• The auditor should use GAS to prepare a list of all other purchases from the vendor. The
auditor should trace the purchases to invoices and to proper recording in the accounts.
• The auditor should consider confirming the total amount of purchases with the outside
vendor.
Significant differences should be recorded as misstatements and projected to the statements as a
whole. If the auditor has suspicions that other such misstatements might exist in the accounts, the
auditor should use GAS to schedule all entries to the account balance that come from other than
the purchase journal and should investigate all of the entries in a similar manner.
12-63
a. The statement of facts for this case reveals that company management had made
promises (earnings expectations) to investors and Wall Street that were not going to materialize,
thereby suggesting the motivation for management. Further, it is likely that the controls in place
were not very effective. While Safety-Kleen had policies prohibiting the types of fraudulent
entries that were being made, presumably there was no monitoring or review of adherence to
these policies. And students can often see how management might provide rationalizations for
the fraud (for example, not our fault the numbers are not being meant, we shouldn’t suffer
because of something outside of our control, etc.).
b. It is important to note that this response has the benefit of hindsight. However, analytical
procedures (either planning or substantive) should have noted the increases in quarter end
adjustments, with rather significant adjustments occurring in the 3
rd
and 4
th
quarters of 1999.
Further, the 2000 1
st
quarter adjustment was quite a bit larger than the previous 1
st
quarter
adjustment. The case states that these adjustments in 1999 were significantly higher than the
adjustments in previous. We assume that these balances in 1999 and 2000 were different than
what an auditor, knowledgeable of the industry, would expect. Therefore, the auditor should
have followed up on these unexpected account balances to determine if there was supporting
documentation to validate the balances. The statement of facts for the case indicates that for the
$7.3 million of fraudulent adjustments to capitalize the tires on the company's trucks and the fuel
in the tanks, a company executive sketched these adjustments on graph paper, without any
analysis or documentation to support them.
The problem states that one of the adjusting entries was recorded twice. The use of GAS or other
procedures should have identified this duplicate recording.
Further, the auditor should likely have selected capitalized items and reviewed documentation to
determine whether the capitalization was appropriate or whether the items (such as salary
expense) should have been expensed.
12-18
• The auditor should determine that the document that is examined was not used to support
other purchases, that is, the auditor should be suspicious of the information because it is
all obtained internally. The auditor should be concerned that one invoice might serve as
support for this journal entry and another purchase.
• The auditor should use GAS to prepare a list of all other purchases from the vendor. The
auditor should trace the purchases to invoices and to proper recording in the accounts.
• The auditor should consider confirming the total amount of purchases with the outside
vendor.
Significant differences should be recorded as misstatements and projected to the statements as a
whole. If the auditor has suspicions that other such misstatements might exist in the accounts, the
auditor should use GAS to schedule all entries to the account balance that come from other than
the purchase journal and should investigate all of the entries in a similar manner.
12-63
a. The statement of facts for this case reveals that company management had made
promises (earnings expectations) to investors and Wall Street that were not going to materialize,
thereby suggesting the motivation for management. Further, it is likely that the controls in place
were not very effective. While Safety-Kleen had policies prohibiting the types of fraudulent
entries that were being made, presumably there was no monitoring or review of adherence to
these policies. And students can often see how management might provide rationalizations for
the fraud (for example, not our fault the numbers are not being meant, we shouldn’t suffer
because of something outside of our control, etc.).
b. It is important to note that this response has the benefit of hindsight. However, analytical
procedures (either planning or substantive) should have noted the increases in quarter end
adjustments, with rather significant adjustments occurring in the 3
rd
and 4
th
quarters of 1999.
Further, the 2000 1
st
quarter adjustment was quite a bit larger than the previous 1
st
quarter
adjustment. The case states that these adjustments in 1999 were significantly higher than the
adjustments in previous. We assume that these balances in 1999 and 2000 were different than
what an auditor, knowledgeable of the industry, would expect. Therefore, the auditor should
have followed up on these unexpected account balances to determine if there was supporting
documentation to validate the balances. The statement of facts for the case indicates that for the
$7.3 million of fraudulent adjustments to capitalize the tires on the company's trucks and the fuel
in the tanks, a company executive sketched these adjustments on graph paper, without any
analysis or documentation to support them.
The problem states that one of the adjusting entries was recorded twice. The use of GAS or other
procedures should have identified this duplicate recording.
Further, the auditor should likely have selected capitalized items and reviewed documentation to
determine whether the capitalization was appropriate or whether the items (such as salary
expense) should have been expensed.
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-19
Students might also expect that audit work in the area of payroll expenses might have identified
an unexpected decrease in payroll expenses and that follow-up of this unexpected result might
have identified the inappropriate capitalization.
Application Activities
12-64
The point of this exercise is to get students to access online financial reports, to see the
relationship to conceptual auditing topics involving impairments, and to read and interpret
financial statement disclosures. Further, discussing each student’s findings in a small group or
even as an entire class may prove beneficial in stimulating conversation about the nature of
impairment charges, their causes, their magnitudes, and implications for the external auditor in
terms of assessing reasonableness of the estimates made by management.
There are many recent examples that students might find including:
• In 2014, Caesars Entertainment Corp. posted a large quarterly loss after taking a hefty
impairment charge. The casino corporation said it took goodwill and asset-impairment
charges because of the continuing slump in Atlantic City and expectations that some
property holdings may not last as long as expected.
• Best Buy, for the fiscal year ended March 3, 2012
• Sears Holding Corporation, for the fiscal year ended January 28, 2012
• AT&T Inc., for the fiscal year ended December 31, 2011
For a less recent example, consider that Starbuck’s recorded a $224 million impairment charge in
2009, and that was following a $325 million impairment charge in 2008. These impairment
charges were associated with a significant slowdown in the Company’s expansion, with fewer
store openings attributed to reduced demand and a steep decline in discretionary consumer
spending related to the recession. Note 2 of Starbuck’s Annual Report provides a nice summary
of the Company’s restructuring plan.
While the judgments that management made may vary across the selected companies, typical
judgments that management makes concern expected useful lives of long-lived assets,
undiscounted cash flows, and anticipated changes in economic conditions and operating
performance. Necessarily, these types of estimates are by definition uncertain. Thus, the job of
the auditor is to assess their reasonableness and to be professionally skeptical of the numbers
produced by management based upon these estimates.
12-65
DRG Audits- Excerpts from PCAOB Order
DRG reported in the notes to its 2008 financial statements that it had incurred advertising
expenses during 2008 and that it had capitalized approximately $840,000 of those expenses as
12-19
Students might also expect that audit work in the area of payroll expenses might have identified
an unexpected decrease in payroll expenses and that follow-up of this unexpected result might
have identified the inappropriate capitalization.
Application Activities
12-64
The point of this exercise is to get students to access online financial reports, to see the
relationship to conceptual auditing topics involving impairments, and to read and interpret
financial statement disclosures. Further, discussing each student’s findings in a small group or
even as an entire class may prove beneficial in stimulating conversation about the nature of
impairment charges, their causes, their magnitudes, and implications for the external auditor in
terms of assessing reasonableness of the estimates made by management.
There are many recent examples that students might find including:
• In 2014, Caesars Entertainment Corp. posted a large quarterly loss after taking a hefty
impairment charge. The casino corporation said it took goodwill and asset-impairment
charges because of the continuing slump in Atlantic City and expectations that some
property holdings may not last as long as expected.
• Best Buy, for the fiscal year ended March 3, 2012
• Sears Holding Corporation, for the fiscal year ended January 28, 2012
• AT&T Inc., for the fiscal year ended December 31, 2011
For a less recent example, consider that Starbuck’s recorded a $224 million impairment charge in
2009, and that was following a $325 million impairment charge in 2008. These impairment
charges were associated with a significant slowdown in the Company’s expansion, with fewer
store openings attributed to reduced demand and a steep decline in discretionary consumer
spending related to the recession. Note 2 of Starbuck’s Annual Report provides a nice summary
of the Company’s restructuring plan.
While the judgments that management made may vary across the selected companies, typical
judgments that management makes concern expected useful lives of long-lived assets,
undiscounted cash flows, and anticipated changes in economic conditions and operating
performance. Necessarily, these types of estimates are by definition uncertain. Thus, the job of
the auditor is to assess their reasonableness and to be professionally skeptical of the numbers
produced by management based upon these estimates.
12-65
DRG Audits- Excerpts from PCAOB Order
DRG reported in the notes to its 2008 financial statements that it had incurred advertising
expenses during 2008 and that it had capitalized approximately $840,000 of those expenses as
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-20
"direct response advertising" pursuant to AICPA Statement of Position ("SOP") 93-7, Reporting
on Advertising Costs (December 29, 1993). DRG's capitalized direct response advertising
balance for 2008 represented an increase of over 350% from the prior year and constituted 21%
of DRG's total reported assets.
SOP 93-7 provides that a company may only capitalize advertising expenses as direct response
advertising if (1) the primary purpose of the advertising "is to elicit sales to customers who could
be shown to have responded specifically to the advertising;" and (2) the advertising "results in
probable future benefits." In addition, SOP 93-7 states that direct response advertising costs
reported as assets are to be "amortized on a cost-pool-by-cost-pool basis over the period during
which the future benefits are expected to be received.”
During the 2008 audit, JSW failed to exercise due professional care and failed to obtain
sufficient audit evidence to conclude that DRG was appropriately capitalizing, as opposed to
expensing, the costs it reported as direct response advertising. Specifically, JSW failed to obtain
audit evidence indicating that sales were to customers responding specifically to the advertising.
Nor did JSW obtain sufficient competent audit evidence indicating that the advertising would
result in probable future benefits to DRG. In addition, JSW failed to perform any procedures to
evaluate whether DRG was appropriately amortizing the amounts it capitalized as direct response
advertising. Indeed, JSW's work papers include a schedule, provided by DRG, indicating that the
company was not amortizing those amounts.
DDM Audits- Excerpts from PCAOB Order
As of year-end 2008, more than 75% of DDM's total reported assets were classified as intangible
assets and consisted mostly of website and platform development costs for an unlaunched
product. During the 2008 audit, JSW failed to ensure that the engagement team appropriately
tested DDM's intangible asset balance for impairment. The work papers reflect that
management's basis for not recognizing an impairment on its intangible assets in 2008 was a cash
flow projection. JSW, however, performed no procedures to assess the reasonableness of the
cash flow projection, including the relevance, sufficiency, and reliability of the data supporting
the projection and the assumptions management made in formulating the projection. In addition,
the untested cash flow projection was inconsistent with JSW's conclusion that there was
substantial doubt as to DDM's ability to continue operating as a going concern.
Sanctions
Accordingly, it is hereby ORDERED that: A. Pursuant to Section 105(c)(4)(E) of the Act and
PCAOB Rule 5300(a)(5), Jewett, Schwartz, Wolfe & Associates, P.L. is hereby censured.
Pursuant to Section 105(c)(4)(A) of the Act and PCAOB Rule 5300(a)(1), the registration of
Jewett, Schwartz, Wolfe & Associates, P.L. is revoked.
After five (5) years from the date of this Order, Jewett, Schwartz, Wolfe & Associates, P.L. may
reapply for registration by filing an application pursuant to PCAOB Rule 2101.
12-20
"direct response advertising" pursuant to AICPA Statement of Position ("SOP") 93-7, Reporting
on Advertising Costs (December 29, 1993). DRG's capitalized direct response advertising
balance for 2008 represented an increase of over 350% from the prior year and constituted 21%
of DRG's total reported assets.
SOP 93-7 provides that a company may only capitalize advertising expenses as direct response
advertising if (1) the primary purpose of the advertising "is to elicit sales to customers who could
be shown to have responded specifically to the advertising;" and (2) the advertising "results in
probable future benefits." In addition, SOP 93-7 states that direct response advertising costs
reported as assets are to be "amortized on a cost-pool-by-cost-pool basis over the period during
which the future benefits are expected to be received.”
During the 2008 audit, JSW failed to exercise due professional care and failed to obtain
sufficient audit evidence to conclude that DRG was appropriately capitalizing, as opposed to
expensing, the costs it reported as direct response advertising. Specifically, JSW failed to obtain
audit evidence indicating that sales were to customers responding specifically to the advertising.
Nor did JSW obtain sufficient competent audit evidence indicating that the advertising would
result in probable future benefits to DRG. In addition, JSW failed to perform any procedures to
evaluate whether DRG was appropriately amortizing the amounts it capitalized as direct response
advertising. Indeed, JSW's work papers include a schedule, provided by DRG, indicating that the
company was not amortizing those amounts.
DDM Audits- Excerpts from PCAOB Order
As of year-end 2008, more than 75% of DDM's total reported assets were classified as intangible
assets and consisted mostly of website and platform development costs for an unlaunched
product. During the 2008 audit, JSW failed to ensure that the engagement team appropriately
tested DDM's intangible asset balance for impairment. The work papers reflect that
management's basis for not recognizing an impairment on its intangible assets in 2008 was a cash
flow projection. JSW, however, performed no procedures to assess the reasonableness of the
cash flow projection, including the relevance, sufficiency, and reliability of the data supporting
the projection and the assumptions management made in formulating the projection. In addition,
the untested cash flow projection was inconsistent with JSW's conclusion that there was
substantial doubt as to DDM's ability to continue operating as a going concern.
Sanctions
Accordingly, it is hereby ORDERED that: A. Pursuant to Section 105(c)(4)(E) of the Act and
PCAOB Rule 5300(a)(5), Jewett, Schwartz, Wolfe & Associates, P.L. is hereby censured.
Pursuant to Section 105(c)(4)(A) of the Act and PCAOB Rule 5300(a)(1), the registration of
Jewett, Schwartz, Wolfe & Associates, P.L. is revoked.
After five (5) years from the date of this Order, Jewett, Schwartz, Wolfe & Associates, P.L. may
reapply for registration by filing an application pursuant to PCAOB Rule 2101.
Exploring the Variety of Random
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accessible points on the railway as may, from time to time, be
nearest to the armies in the field, the leading stations en route are
required to serve a variety of military purposes; though in each and
every such instance the system of organisation is such that the
duties to be discharged or the responsibilities to be fulfilled are
undertaken by, or are under the control of, a Commission formed on
the now established basis of representation thereon of both the
military and the technical elements.
For the conveyance of troops, there are, in the first place,
Mobilisation Stations and Junction Stations, whence the men within
a certain district are sent to the Embarkation Stations, at which
complete units for the front are made up. These are followed by
Stations for Meals ("Stations haltes-repas"), for men and horses;
though in this case the "stations" may really be goods or locomotive
sheds, able to accommodate a large number of men. At the end of
the railway line, so far as it is available for troops, come the
Detraining Stations.
In regard to supplies and stores, the first link in the chain of
organisation is constituted by the Base Supply Stations ("gares de
rassemblement"). Here the supplies going from a certain district
outside the theatre of operations to any one Army Corps must be
delivered; and here they are checked, made up into full train loads,
or otherwise dealt with in such a way as to simplify and facilitate
their further transport.
In certain cases full train-loads arriving at these assembling stations
pass through to destination, after being checked; but the general
practice is for the consignments forwarded from base supply stations
to go to the Supply Depôts ("Stations-magasins"), serving the
purposes of storehouses from which supplies, whether received from
the base or collected locally, can be despatched in just such
quantities, and at just such intervals, as circumstances may require.
These depôts are organised on a different basis according to the
particular service or purpose for which they are designed,—Cavalry,
Engineers, Artillery, Medical, Telegraph Corps; provisions, live stock,
nearest to the armies in the field, the leading stations en route are
required to serve a variety of military purposes; though in each and
every such instance the system of organisation is such that the
duties to be discharged or the responsibilities to be fulfilled are
undertaken by, or are under the control of, a Commission formed on
the now established basis of representation thereon of both the
military and the technical elements.
For the conveyance of troops, there are, in the first place,
Mobilisation Stations and Junction Stations, whence the men within
a certain district are sent to the Embarkation Stations, at which
complete units for the front are made up. These are followed by
Stations for Meals ("Stations haltes-repas"), for men and horses;
though in this case the "stations" may really be goods or locomotive
sheds, able to accommodate a large number of men. At the end of
the railway line, so far as it is available for troops, come the
Detraining Stations.
In regard to supplies and stores, the first link in the chain of
organisation is constituted by the Base Supply Stations ("gares de
rassemblement"). Here the supplies going from a certain district
outside the theatre of operations to any one Army Corps must be
delivered; and here they are checked, made up into full train loads,
or otherwise dealt with in such a way as to simplify and facilitate
their further transport.
In certain cases full train-loads arriving at these assembling stations
pass through to destination, after being checked; but the general
practice is for the consignments forwarded from base supply stations
to go to the Supply Depôts ("Stations-magasins"), serving the
purposes of storehouses from which supplies, whether received from
the base or collected locally, can be despatched in just such
quantities, and at just such intervals, as circumstances may require.
These depôts are organised on a different basis according to the
particular service or purpose for which they are designed,—Cavalry,
Engineers, Artillery, Medical, Telegraph Corps; provisions, live stock,
clothing, camp equipment, etc. Their number, character, and location
are decided by the Minister of War in time of peace. On the outbreak
of war those in the Zone of the Armies pass under the control of the
Commander-in-Chief together with the railway lines within that zone.
The situation of the depôts may be changed, or additional depôts
may be opened, by the Directeur de l'Arrière, with the consent of the
Commander-in-Chief.
Each station depôt is under the charge of the military member of the
Station Commission. His special function it is to supply therefrom the
wants of the Army in accordance with the demands he receives.
These demands he distributes among the different departments of
the depôt, giving instructions as to the time by which the railway
wagons must be loaded. He also takes, with the stationmaster, all
the necessary measures for ensuring the making up, the loading,
and the departure of the trains; but he must not interfere with the
internal administration of the station or with the technical direction
and execution of the railway services.
Provision is also made for the immediate unloading of trains bringing
supplies to the station depôts for storage there, the military
commissioner being expressly instructed to guard against any block
on the lines in or near to the station. Wagons need not be unloaded
if they are to be sent on after only a brief detention, or if they
contain ammunition forming part of the current needs of the Army.
From the supply depôts the supplies and stores pass on to the
Regulating Station ("gare régulatrice"). This is located at such point
on each line of communication as, while allowing of a final regulation
of supplies going to the front, does not—owing to its nearness to the
fighting line—permit of any guarantee of a fixed train service beyond
that point. The locality of the regulating station is changed from day
to day, or from time to time, according to developments in the
military situation.
The regulating station is in charge of a Regulating Commission
("Commission régulatrice"), constituted on the same basis as a Sub-
Line Commission. Receiving orders or instructions as to the nature
are decided by the Minister of War in time of peace. On the outbreak
of war those in the Zone of the Armies pass under the control of the
Commander-in-Chief together with the railway lines within that zone.
The situation of the depôts may be changed, or additional depôts
may be opened, by the Directeur de l'Arrière, with the consent of the
Commander-in-Chief.
Each station depôt is under the charge of the military member of the
Station Commission. His special function it is to supply therefrom the
wants of the Army in accordance with the demands he receives.
These demands he distributes among the different departments of
the depôt, giving instructions as to the time by which the railway
wagons must be loaded. He also takes, with the stationmaster, all
the necessary measures for ensuring the making up, the loading,
and the departure of the trains; but he must not interfere with the
internal administration of the station or with the technical direction
and execution of the railway services.
Provision is also made for the immediate unloading of trains bringing
supplies to the station depôts for storage there, the military
commissioner being expressly instructed to guard against any block
on the lines in or near to the station. Wagons need not be unloaded
if they are to be sent on after only a brief detention, or if they
contain ammunition forming part of the current needs of the Army.
From the supply depôts the supplies and stores pass on to the
Regulating Station ("gare régulatrice"). This is located at such point
on each line of communication as, while allowing of a final regulation
of supplies going to the front, does not—owing to its nearness to the
fighting line—permit of any guarantee of a fixed train service beyond
that point. The locality of the regulating station is changed from day
to day, or from time to time, according to developments in the
military situation.
The regulating station is in charge of a Regulating Commission
("Commission régulatrice"), constituted on the same basis as a Sub-
Line Commission. Receiving orders or instructions as to the nature
and quantities of the supplies and stores required by the troops at
the front, and drawing these from the supply depôts, the
Commission must always have on hand a sufficiency to meet
requirements. It is, also, left to the Commission to arrange for the
further despatch of the supplies from the regulating station by
means of such trains as, in the circumstances of the moment, may
be found practicable.
As a matter of daily routine, and without further instructions, the
supply depôts send one train of provisions each day to the
regulating station, and the latter sends on one train daily to the
front, always, however, keeping a further day's supply on hand, at or
near the regulating station, to meet further possible requirements.
Additional trains, whether from the supply depôts or from the
regulating station (where rolling stock is kept available) are made up
as needed.
Supplementing these arrangements, the Regulating Commission
may, at the request of the Director of Road Services, further keep
permanently within its zone of action a certain number of wagons of
provisions in readiness to meet contingencies, the wagons so utilised
as Stores on wheels being known as "en-cas mobiles." Should the
Directeur de l'Arrière so desire, railway wagons with ammunition
can, in the same way, be kept loaded at any station within the Zone
of the Armies, or, by arrangement with the Minister of War, in the
Zone of the Interior. It is, however, stipulated that the number of
these wagons should be reduced to a minimum, in order to avoid
congestion either of the stations or of the railway lines.
Beyond the regulating station comes Railhead, which constitutes the
furthest limit of possible rail-transport for the time being, and the
final point of connection between rail and road services, the latter
being left with the responsibility of continuing the line of
communication thence to the armies on the field of battle.
It is the duty of the Regulating Commission, as soon as it enters on
the discharge of its functions and as often afterwards as may be
necessary, to advise both the General in command of the Army
the front, and drawing these from the supply depôts, the
Commission must always have on hand a sufficiency to meet
requirements. It is, also, left to the Commission to arrange for the
further despatch of the supplies from the regulating station by
means of such trains as, in the circumstances of the moment, may
be found practicable.
As a matter of daily routine, and without further instructions, the
supply depôts send one train of provisions each day to the
regulating station, and the latter sends on one train daily to the
front, always, however, keeping a further day's supply on hand, at or
near the regulating station, to meet further possible requirements.
Additional trains, whether from the supply depôts or from the
regulating station (where rolling stock is kept available) are made up
as needed.
Supplementing these arrangements, the Regulating Commission
may, at the request of the Director of Road Services, further keep
permanently within its zone of action a certain number of wagons of
provisions in readiness to meet contingencies, the wagons so utilised
as Stores on wheels being known as "en-cas mobiles." Should the
Directeur de l'Arrière so desire, railway wagons with ammunition
can, in the same way, be kept loaded at any station within the Zone
of the Armies, or, by arrangement with the Minister of War, in the
Zone of the Interior. It is, however, stipulated that the number of
these wagons should be reduced to a minimum, in order to avoid
congestion either of the stations or of the railway lines.
Beyond the regulating station comes Railhead, which constitutes the
furthest limit of possible rail-transport for the time being, and the
final point of connection between rail and road services, the latter
being left with the responsibility of continuing the line of
communication thence to the armies on the field of battle.
It is the duty of the Regulating Commission, as soon as it enters on
the discharge of its functions and as often afterwards as may be
necessary, to advise both the General in command of the Army
served by the line of communication and the Director of Road
Services as to the station which can be used as railhead and the
facilities offered there for the accommodation, unloading, and
loading of wagons. On the basis of the information so given the
General-in-Command decides each day, or as the occasion requires,
on the particular station which shall be regarded as railhead for the
purposes of transport. He advises the Regulating Commission and
the Director of Road Services accordingly, and he further notifies to
them his wishes in regard to the forwarding of supplies to the point
thus fixed.
These elaborate arrangements for ensuring a maintenance of
efficiency along the whole line of communication from the interior to
the front equally apply to transport of all kinds from the theatre of
war to the interior. In principle, evacuations from the army of sick
and wounded, prisoners, surplus stores, and so on, are effected
from railhead by means of the daily supply-trains returning thence to
the regulating station, where the Regulating Commission takes them
in charge, and passes them on by the trains going back to the Depôt
Stations, or beyond. Should special trains be necessary for the
removal of a large number of wounded, or otherwise, the Director of
Road Services communicates with the Regulating Commission, which
either makes up the desired specials from the rolling stock it has on
hand or, if it cannot do this, itself applies, in turn, to the Director of
Railways.
For dealing with the sick and wounded, every possible provision is
made under the authority of the Minister of War and the Director-
General, the arrangements in advance, as detailed in the decrees
relating to this branch of the subject, being on the most
comprehensive scale. Among other measures provided for is the
setting up of Evacuation Hospitals ("hôpitaux d'évacuation") in the
immediate neighbourhood of the Regulating Stations, if not, also, at
railhead. Elsewhere along the line certain stations become Infirmary
Stations, ("infirmaries de gare") where, in urgent cases, and under
conditions laid down by the War Minister, the sick and wounded en
route to the interior can receive prompt medical attention in case of
Services as to the station which can be used as railhead and the
facilities offered there for the accommodation, unloading, and
loading of wagons. On the basis of the information so given the
General-in-Command decides each day, or as the occasion requires,
on the particular station which shall be regarded as railhead for the
purposes of transport. He advises the Regulating Commission and
the Director of Road Services accordingly, and he further notifies to
them his wishes in regard to the forwarding of supplies to the point
thus fixed.
These elaborate arrangements for ensuring a maintenance of
efficiency along the whole line of communication from the interior to
the front equally apply to transport of all kinds from the theatre of
war to the interior. In principle, evacuations from the army of sick
and wounded, prisoners, surplus stores, and so on, are effected
from railhead by means of the daily supply-trains returning thence to
the regulating station, where the Regulating Commission takes them
in charge, and passes them on by the trains going back to the Depôt
Stations, or beyond. Should special trains be necessary for the
removal of a large number of wounded, or otherwise, the Director of
Road Services communicates with the Regulating Commission, which
either makes up the desired specials from the rolling stock it has on
hand or, if it cannot do this, itself applies, in turn, to the Director of
Railways.
For dealing with the sick and wounded, every possible provision is
made under the authority of the Minister of War and the Director-
General, the arrangements in advance, as detailed in the decrees
relating to this branch of the subject, being on the most
comprehensive scale. Among other measures provided for is the
setting up of Evacuation Hospitals ("hôpitaux d'évacuation") in the
immediate neighbourhood of the Regulating Stations, if not, also, at
railhead. Elsewhere along the line certain stations become Infirmary
Stations, ("infirmaries de gare") where, in urgent cases, and under
conditions laid down by the War Minister, the sick and wounded en
route to the interior can receive prompt medical attention in case of
need. From the Distribution Stations ("gares de répartition"), the sick
and wounded are sent to the hospitals in the interior to which they
may be assigned.
It will be seen that this comprehensive scheme of organisation aims
at preventing the recurrence of any of those defects or deficiencies
which characterised the military rail-transport movements of France
in the war of 1870-71.
The presence, at every important link in the chain of rail
communication, of a Commission designed to secure regularity and
efficiency in the traffic arrangements should avoid confusion,
congestion and delay.
The association, on each of these Commissions, of the military and
technical elements, with a strict definition of their respective powers,
duties and responsibilities, should ensure the best use of the
available transport facilities under conditions in themselves
practicable, and without the risk either of friction between the
representatives of the two interests or, alternatively, of any
interference with the railway services owing to contradictory or
impossible orders being given by individual officers acting on their
own responsibility.
The setting up of the supply depôts and regulating stations along
the line of communication should prevent (i) the rushing through of
supplies in excessive quantities to the extreme front; (ii) the
congestion of railway lines and stations; (iii) the undue accumulation
of provisions at one point, with a corresponding deficiency
elsewhere, and (iv) the possibility of large stocks being eventually
seized by the enemy and made use of by him to his own advantage.
The measures adopted both to prevent any excessive employment of
railway wagons as storehouses on wheels and to secure their prompt
unloading should afford a greater guarantee of the best utilisation of
rolling stock under conditions of, possibly, extreme urgency.
Finally, the unification of control, the co-ordination of the many
different services involved, and the harmony of working established
and wounded are sent to the hospitals in the interior to which they
may be assigned.
It will be seen that this comprehensive scheme of organisation aims
at preventing the recurrence of any of those defects or deficiencies
which characterised the military rail-transport movements of France
in the war of 1870-71.
The presence, at every important link in the chain of rail
communication, of a Commission designed to secure regularity and
efficiency in the traffic arrangements should avoid confusion,
congestion and delay.
The association, on each of these Commissions, of the military and
technical elements, with a strict definition of their respective powers,
duties and responsibilities, should ensure the best use of the
available transport facilities under conditions in themselves
practicable, and without the risk either of friction between the
representatives of the two interests or, alternatively, of any
interference with the railway services owing to contradictory or
impossible orders being given by individual officers acting on their
own responsibility.
The setting up of the supply depôts and regulating stations along
the line of communication should prevent (i) the rushing through of
supplies in excessive quantities to the extreme front; (ii) the
congestion of railway lines and stations; (iii) the undue accumulation
of provisions at one point, with a corresponding deficiency
elsewhere, and (iv) the possibility of large stocks being eventually
seized by the enemy and made use of by him to his own advantage.
The measures adopted both to prevent any excessive employment of
railway wagons as storehouses on wheels and to secure their prompt
unloading should afford a greater guarantee of the best utilisation of
rolling stock under conditions of, possibly, extreme urgency.
Finally, the unification of control, the co-ordination of the many
different services involved, and the harmony of working established
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