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Auditing and Accounting Cases Investigating Issues of Fraud and Professional Ethics 4th Edition Thibodeau Solutions Manual 1
Auditing and Accounting Cases Investigating Issues of Fraud and Professional Ethics 4th Edition Thibodeau Solutions Manual 1
To maximize a student’s knowledge acquisition of this material, this book has been designed to
be read in conjunction with the post–Sarbanes-Oxley technical audit guidance. All of the
PCAOB Auditing Standards that are referenced in this book are available for free at
http://pcaobus.org/STANDARDS/Pages/default.aspx. In addition, a summary of the provisions
of the Sarbanes-Oxley Act of 2002 is available for free on the book’s website at
www.mhhe.com/thibodeau4e or at http://www.aicpa.org/Pages/Default.aspx.
Section 204
Section 301
Paragraph #17-23
Paragraph #4-8
This case provides students with the opportunity to understand what is meant by an audit
firm exercising due care in completing the audit and the consequences associated with a failure
to do so. It is important to emphasize to students that the consequences attach to both the firm
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Case 2.5 - Sunbeam: Due Care
and the individual auditor. In addition, the case provides a context to discuss what is meant by
an adjusting journal entry proposed by an auditor and the issues associated with an auditor’s
decision about whether to require that such entries be recorded. Finally, the case provides an
opportunity for instructors to discuss the role of the audit committee in helping to prevent these
types of situations. To meet these objectives, this case illuminates a number of relevant
accounting issues that surfaced during the audits of Sunbeam and the client’s refusal to record
We believe it is essential for students to carefully read over the recommended technical
knowledge, along with this case reading. The educational psychology literature suggests that the
acquisition of technical/factual type knowledge increases dramatically when such knowledge can
be applied in a realistic context. Thus, we urge instructors to use this case as a mechanism to
This case assignment will work best if it is scheduled to coincide with the auditors'
professional responsibilities topic in the auditing course. Alternatively, the case can be used in
connection with a discussion of quality control at an audit firm. Or, this case could be used when
discussing the completion of the audit topic as a way to illustrate the issues involved when asking
We recommend that instructors spend time explaining the nature of adjusting journal
entries proposed by auditors. Depending on the point of the semester where this case is used,
students may need to gain an understanding of what is meant by an auditor’s proposed adjusting
journal entry. This can be accomplished quite effectively while going over questions number one
and two. Interestingly, Sunbeam’s first year improprieties were designed to decrease net income,
while Sunbeam’s second year improprieties were designed to increase net income. The case
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Case 2.5 - Sunbeam: Due Care
provides a mechanism to explain the different motivations of managers in each of these different
years.
We also recommend that instructors spend time discussing the nature of the quality control
process at an audit firm. This discussion can be accomplished quite effectively while going over
the response to question number three in the case. That is, it is useful to ask students how they
think Harlow was able to justify his decision to the concurring review partner. This may provide
an opportunity to discuss materiality and the subjectivity associated with estimating materiality.
Finally, question four provides instructors with an opportunity to discuss the increased role of the
audit committee in the post-Sarbanes environment and whether that would have made a difference
1. Consult Paragraphs 4-8 of PCAOB Auditing Standard No. 15. Next, consider the alleged
accounting improprieties related to increased expenses from the 1996 audit. If you were
auditing Sunbeam, what type of evidence would you like to review to determine whether
Sunbeam had recorded the litigation reserve amount and the cooperative advertising
amount in accordance with GAAP?
According to paragraph #4 of PCAOB Auditing Standard No. 15, “The auditor must plan and
perform audit procedures to obtain sufficient appropriate audit evidence to provide a reasonable
basis for his or her opinion.” Next, according to paragraph #6 of PCAOB Auditing Standard No.
15, “To be appropriate, audit evidence must be both relevant and reliable in providing support for
the conclusions on which the auditor's opinion is based.” The relevance of audit evidence
specifically relates to whether the evidence gathered actually relates to the financial statement
assertion being tested. That is, will the evidence allow the auditor to reach conclusions related to
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Case 2.5 - Sunbeam: Due Care
The reliability of the evidence specifically relates to whether the evidence gathered can truly
be relied upon as providing a true indication about the financial statement assertion being tested.
There are a number of factors that should influence an auditor’s conclusions about reliability, the
most important of which is the source (e.g., is it from a third party?) of the audit evidence. Finally,
according to paragraph #5 of PCAOB Auditing Standard No. 15, “sufficiency is the measure of
the quantity of audit evidence.” All things being equal, the greater the risk of material misstatement
related to the financial statement assertion, the more audit evidence will be gathered by the auditor.
In 1996, Sunbeam failed to comply with GAAP by recording a $12 million reserve for a
lawsuit that alleged Sunbeam’s potential obligation to cover a portion of the cleanup costs for a
hazardous waste site. Sunbeam’s management did not take appropriate steps to determine
whether the amount should be recorded in accordance with FASB Statement #5. Had they done
so, the reserve would not have passed either of the criteria.
According to FASB statement #5, an accrual and related expense needs to be recorded if the
loss is probable and the amount of the loss is able to be reasonably estimated. Thus, the auditor
would need to determine whether each of these criteria had been met for the $12 Million
litigation reserve. Thus, among other factors, the auditor would want to be sure that the cleanup
costs for the hazardous waste represented a reasonable estimate of the cleanup costs. In order to
be assured of this, the auditor must obtain sufficient and competent evidential matter. According
to the generally accepted auditing standards of field work number three, “Sufficient, competent
to afford a reasonable basis for an opinion regarding the financial statements under audit.”
Andersen did not obtain sufficient, competent evidential matter regarding the hazardous waste
contingency. This could be accomplished in part by reviewing documents such as the following:
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Case 2.5 - Sunbeam: Due Care
Statements made by Sunbeam’s lawyers about the range of estimated liability, including
the most likely amount. One of the primary substantive tests to obtain comfort over the
valuation of an estimated liability is to obtain written, third party confirmation from the
independent estimate has not been obtained by management, it may be appropriate for the
Review copies of all correspondence with pertinent regulatory agencies regarding the
hazardous waste sight. The auditor should confirm the correspondence with pertinent
Review any board of director meeting minutes that relate to the cleanup process.
Review the process that management follows to determine whether a liability and related
Any other evidence that may help to determine whether the criteria in FASB Statement
In 1996, Sunbeam also recognized an excessive figure for a “cooperative advertising” reserve
that was established to fund a portion of its retailers’ costs of running local promotions. The
amount recorded, $21.8 million, was approximately 25% higher than the prior year’s accrual
amount. Andersen should have identified the increase during a horizontal analysis of the
Under GAAP, the matching principle does require that an estimate be made for all expenses
incurred that relate to revenue of that period. Thus, the recording of an estimated “cooperative
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Case 2.5 - Sunbeam: Due Care
advertising” reserve would have been reasonably expected by the auditor. However, the auditor
must determine that the estimate that was recorded as an accrual and the related expense must be
a close approximation of the expected actual costs. In order to test the estimate recorded by
Sunbeam, the auditor would need to fully understand the causal factors associated with this
expense. By understanding the causal factors, the auditor can then determine whether the
estimate made is appropriate under GAAP. For example, given the nature of “cooperative
advertising” expenses, it is likely that sales volume would be a key determinant for the expense
amount. However, in 1996, while the sales volume did not change drastically, the “cooperative
advertising” amount increased by 25%. Andersen should have identified that there was not a
correlation in the change of “cooperative advertising” and sales volume during the analytical
Contractual agreements between Sunbeam and retailers that outlined the agreement
“cooperative advertising”.
“cooperative advertising”.
2. For the excessive litigation reserves and excessive cooperative advertising amount,
identify the journal entry that is likely to have been proposed by Andersen to correct
each of these accounting improprieties. Why would Sunbeam be interested in recording
journal entries that essentially reduced its income before tax in 1996?
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Case 2.5 - Sunbeam: Due Care
For the excessive litigation reserve, Andersen is likely to have proposed a journal entry to
reduce the amount of the reserve and the related expense account. The journal entry proposed
would be:
For the excessive “cooperative advertising” amount, Andersen is likely to have proposed a
journal entry to reduce the amount of the accrual and the related expense account. The journal
In this particular situation, since Sunbeam’s new upper management team was hired during
1996, it is likely that they were interested in trying to make themselves look the best that they
could during 1997. Thus, by overstating the liability accounts in 1996, the upper management
team created a mechanism to reduce the amount of recorded expenses in 1997. As a result of
reducing recorded expenses in 1997, this provided the opportunity for management to look better
in 1997 by sacrificing the “bottom line” in 1996 for which they were not responsible.
3. Consult Paragraphs 17-23 of PCAOB Auditing Standard No. 14. As discussed in the case,
during both the 1996 and 1997 audit, Phillip Harlow allegedly discovered a number of
different accounting entries made by Sunbeam that were not compliant with Generally
Accepted Accounting Principles (GAAP). Speculate about how Harlow might have
explained his decision not to require Sunbeam to correct these alleged misstatements in
the audit working papers.
This question is designed to get the students to think about documenting their rationale in the
working papers for professional judgments. According to paragraph #17 of PCAOB Auditing
Standard No. 14, “The auditor should evaluate whether uncorrected misstatements are material,
individually or in combination with other misstatements. In making this evaluation, the auditor
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Case 2.5 - Sunbeam: Due Care
should evaluate the misstatements in relation to the specific accounts and disclosures involved
and to the financial statements as a whole, taking into account relevant quantitative and
qualitative factors.” This implies that Mr. Harlow should have critically thought through the
overall implications of these accounting entries. Indeed, since Mr. Harlow discovered these
accounting entries that were not compliant with GAAP, he would have had no choice but to
carefully document his rationale for passing on the audit adjustments in the working papers. He
He may have argued that the journal entries were each immaterial and thus would not be
of interest to the readers of the financial statements. By doing so, Mr. Harlow would
have to argue that the journal entry would not change or influence the judgment of a
reasonable person. To do so, he may have arbitrarily increased the assessed materiality
level in the work papers and tried to justify the increase in a number of different ways.
reasonable (with regard to the reserve) or by trying to find “independent” experts that
that the procedure management used to reasonably estimate the amount of the reserve
was appropriate.
He may have argued that management’s refusal to record the proposed adjustments was
based on the notion that the proposed adjustments were based upon subjective estimates,
appropriate.
4. Consult Sections 204 and 301 of SARBOX. In the post-Sarbanes audit environment,
which of the issues that arose in 1996 and 1997 would have to be reported to the audit
committee at Sunbeam? Do you believe that communication to the audit committee
would have made a difference in Harlow’s decision not to record the adjusting journal
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Case 2.5 - Sunbeam: Due Care
According to Section 301 of SARBOX, the “audit committee of an issuer shall be directly
responsible for the appointment, compensation, and oversight of the work of any registered
public accounting firm employed by that issuer.” Moreover, according to Section 204, the
auditing firm must report all “critical accounting policies and practices” and “all alternative
treatments of financial information within [GAAP] that have been discussed with management”
as well as the “ramifications of the use of such alternative disclosures and treatments, and the
treatment preferred” by the auditing firm. This is an important component of the oversight role
played by the audit committee. Based on the revised technical guidance, for Sunbeam,
communication of each of these proposed adjustments to the audit committee would have likely
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