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

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Auditing Cases
S I X T H E D I T I O N
Resource Manual
Mark S. Beasley
Frank A. Buckless
Steven M. Glover
Douglas F. Prawitt

T A B L E O F C O N T E N T S
i
CASES INCLUDED IN THIS SECTION
Client AcceptanceS E C T I O N
1
1.1 Ocean Manufacturing, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
The New Client Acceptance Decision
CASES INCLUDED IN THIS SECTION
Understanding the Client’s Business
and Assessing Risk
S E C T I O N
2
2.1 Your1040Return.com . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Evaluating eBusiness Revenue Recognition, Information Privacy,
and Electronic Evidence Issues
2.2 Apple Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Evaluation of Client Business Risk
2.3 Flash Technologies, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Risk Analysis
2.4 Asher Farms Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
Understanding of Client’s Business Environment
CASES INCLUDED IN THIS SECTION
Professional and Ethical IssuesS E C T I O N
3
3.1 A Day in the Life of Brent Dorsey . . . . . . . . . . . . . . . . . . . . . . . 67
Staff Auditor Professional Pressures
3.2 Nathan Johnson’s Rental Car Reimbursement . . . . . . . . . . . . . . . . 71
Should He Pocket the Cash?
3.3 The Anonymous Caller . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
Recognizing It’s a Fraud and Evaluating What to Do
3.4 WorldCom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
The Story of a Whistleblower
3.5 Hollinger International . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
Realities of Audit-Related Litigation
I N T R O D U C T I O N Professional Judgment . . . . . . . . . . . . . . . . 1

T A B L E O F C O N T E N T S
ii
CASES INCLUDED IN THIS SECTION
Accounting Fraud and Auditor Legal LiabilityS E C T I O N
4
4.1 Enron Corporation and Andersen, LLP . . . . . . . . . . . . . . . . . . 103
Analyzing the Fall of Two Giants
4.2 Comptronix Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . 113
Identifying Inherent Risk and Control Risk Factors
4.3 Cendant Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127
Assessing the Control Environment and Evaluating Risk of
Financial Statement Fraud
4.4 Waste Management, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . 135
Manipulating Accounting Estimates
4.5 Xerox Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145
Evaluating Risk of Financial Statement Fraud
4.6 Phar-Mor, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159
Accounting Fraud, Litigation, and Auditor Liability
4.7 Satyam Computer Services Limited . . . . . . . . . . . . . . . . . . . . . 175
Controlling the Confirmation Process
CASES INCLUDED IN THIS SECTION
Internal Control over Financial ReportingS E C T I O N
5
5.1 Simply Steam, Co. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185
Evaluation of Internal Control Environment
5.2 Easy Clean, Co. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185
Evaluation of Internal Control Environment
5.3 Red Bluff Inn & Café . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195
Establishing Effective Internal Control in a Small Business
5.4 St. James Clothiers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199
Evaluation of Manual and IT-Based Sales Accounting System Risks
5.5 Collins Harp Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . 209
Recommending IT Systems Development Controls
5.6 Sarbox Scooter, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219
Scoping and Evaluation Judgments in the Audit of Internal
Control over Financial Reporting
5.7 Société Générale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229
How a Low-Risk Trading Area Caused a $7.2 Billion Loss

T A B L E O F C O N T E N T S
iii
CASES INCLUDED IN THIS SECTION
2.1 Your1040Return.com . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Evaluating eBusiness Revenue Recognition, Information Privacy,
and Electronic Evidence Issues
5.4 St. James Clothiers . . . . . . . . . . . . . . . . . . . . . . . . . . . 199
Evaluation of Manual and IT-Based Sales Accounting System Risks
5.5 Collins Harp Enterprises . . . . . . . . . . . . . . . . . . . . . . . . 209
Recommending IT Systems Development Controls
9.2 Henrico Retail, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . 319
Understanding the IT Accounting System and Identifying Audit
Evidence for Retail Sales
OTHER CASES THAT DISCUSS TOPICS RELATED TO THIS SECTION
The Impact of Information TechnologyS E C T I O N
6
6.1 Harley-Davidson, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241
Identifying eBusiness Risks and Related Assurance Services for
the eBusiness Marketplace
6.2 Jacksonville Jaguars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251
Evaluating IT Benefits and Risks and Identifying Trust Services
Opportunities
CASES INCLUDED IN THIS SECTION
OTHER CASES THAT DISCUSS TOPICS RELATED TO THIS SECTION
Planning MaterialityS E C T I O N
7
7.1 Anne Aylor, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267
Determination of Planning Materiality and Tolerable Misstatement
5.6 Sarbox Scooter, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . 219
Scoping and Evaluation Judgments in the Audit of Internal
Control over Financial Reporting
12.1 EyeMax Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . 439
Evaluation of Audit Differences
12.2 Auto Parts, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 449
Considering Materiality When Evaluating Accounting Policies
and Footnote Disclosures

T A B L E O F C O N T E N T S
iv
CASES INCLUDED IN THIS SECTION
OTHER CASES THAT DISCUSS TOPICS RELATED TO THIS SECTION
Analytical ProceduresS E C T I O N
8
8.1 Laramie Wire Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . 277
Using Analytical Procedures in Audit Planning
8.2 Northwest Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283
Developing Expectations for Analytical Procedures
8.3 Burlingham Bees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291
Using Analytical Procedures as Substantive Tests
1.1 Ocean Manufacturing, Inc.

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T A B L E O F C O N T E N T S
v
CASES INCLUDED IN THIS SECTION
Planning and Performing Audit Procedures
in the Revenue and Expenditure Cycles
An Audit Simulation
S E C T I O N
10
10.1 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . . . . . . . . . 369
Identification of Tests of Controls for the Revenue Cycle
(Sales and Cash Receipts)
10.2 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . . . . . . . . . 383
Identification of Substantive Tests for the Revenue Cycle
(Sales and Cash Receipts)
10.3 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . . . . . . . . . 391
Selection of Audit Tests and Risk Assessment for the Revenue Cycle
(Sales and Cash Receipts)
10.4 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . . . . . . . . . 401
Performance of Tests of Transactions for the Expenditure Cycle
(Acquisitions and Cash Disbursements)
10.5 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . . . . . . . .

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T A B L E O F C O N T E N T S
vi
CASES INCLUDED IN THIS SECTION
Completing the Audit, Reporting to
Management, and External Reporting
S E C T I O N
12
12.1 EyeMax Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 439
Evaluation of Audit Differences
12.2 Auto Parts, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 449
Considering Materiality When Evaluating Accounting Policies
and Footnote Disclosures
12.3 K&K Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455
Leveraging Audit Findings to Provide Value-Added Insights in a
Manufacturing Environment
12.4 Surfer Dude Duds, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 461
Considering the Going-Concern Assumption
12.5 Murchison Technologies, Inc. . . . . . . . . . . . . . . . . . . . . . . . . 465
Evaluating an Attorney’s Response and Identifying the Proper
Audit Report
12.6 Going Green . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 477
Sustainability and External Reporting

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

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

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

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1
The case was prepared by Mark S. Beasley, Ph.D. and Frank A. Buckless, Ph.D. of North Carolina State University and Steven M. Glover, Ph.D. and
Douglas F. Prawitt, Ph.D. of Brigham Young University, as a basis for class discussion. It is not intended to illustrate either effective or ineffective
handling of an administrative situation.
Professional Judgment
Understanding and Developing Professional Judgment
in Auditing and Accounting
Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt
[1] To help students understand that the changing
nature of the accounting profession increasingly
requires professionals to use professional judg-
ment (e.g., fair value measurements and princi-
ples-based standards).
[2] To help students gain an understanding of a
good judgment process and practice using it in
an accounting context.
[3] To help students identify, recognize and mitigate
common judgment traps and tendencies.
[4] To help students gain an understanding of
professional skepticism by exploring judgment
frames.
INSTR UCTIONAL OBJECTIVES
BACKGROUND
KPMG LLP, one of the four largest international public accounting firms, launched an initiative in
2009 to enhance the professional judgment and professional skepticism of its people and teams.
KPMG collaborated with two professors at Brigham Young University, Professors Steve Glover
and Doug Prawitt, to emphasize these skills in its training. The result of this effort is refreshed
professional judgment content throughout KPMG's audit training curriculum for all levels of audit
professionals.
KPMG took the additional step of sharing and leveraging its professional judgment training
content to create, again in collaboration with Brigham Young University Professors Glover and
Prawitt, a monograph to help students accelerate the development of their professional judgment
while still in college. The monograph is titled Elevating Professional Judgment in Auditing and
Accounting: The KPMG Professional Judgment Framework. That monograph is available free of
charge for college students and professors on KPMG’s University Connection site. (You can find
the monograph at http://www.kpmguniversityconnection.com). It is only available in electronic
form because it comes as a pdf, with live internet links and audio files embedded. In addition, there
are video files and an instructor’s manual available separately to professors who register on KPMG
University Connection.
This Professional Judgment Module is adapted from the KPMG Elevating Professional
Judgment in Auditing and Accounting monograph. It covers some of the topics that are discussed
and illustrated in more depth in the monograph. This module can be used as an overview for the
monograph and as a brief introduction to professional judgment for those who do not have space in
I N T R O D U C T I O N

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

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3
: Professional Judgment
might not have been considered otherwise. For example, suppose that a client’s revenues have
increased more than any other company in the industry and that the client attributes its success
to a new marketing strategy. The auditor should understand the client’s explanation and then
apply professional skepticism by considering other possibilities, such as an error in revenue
recognition or even financial statement fraud. Considering financial results from that perspective
will help the engagement team identify evidence that could help to either identify or rule out the
possibility of error or fraud.
[3] What is the first step in avoiding traps or reducing bias? Briefly explain why this first step is so
important.
Awareness of potential traps and conditions that lead to bias is the most important factor—it is
a necessary first step before any other efforts to mitigate bias can be implemented.
[4] Identify and briefly describe three potential ways to mitigate the effects of biases.
Actively questioning our assumptions, which might include considering potentially
disconfirming evidence or seeking more complete information, is a key approach in mitigating
all of the judgment biases. Consulting with others can go a long way toward mitigating the
effects of the availability tendency. Getting an outside view on a going-concern uncertainty
assessment can help keep the auditor’s judgment from being too optimistic, or pessimistic, given
recent, salient experiences. In other judgment and decision tasks, a helpful approach is to ask
others to gather and evaluate information without revealing our preference. (We do not want
to reveal our preference because it may affect their judgment just like it may affect our own.)
Finally, we can also take steps to objectively evaluate the pros and cons for each alternative. In
mitigating bias related to the anchoring tendency, it can be helpful to seek out and explicitly
consider alternative anchors.
DISCUSSION CASES
[1] An audit engagement team is planning for the upcoming audit of a client who recently
underwent a significant restructuring of its debt. The restructuring was necessary as economic
conditions hampered the client’s ability to make scheduled re-payments of its debt obligations.
The restructured debt agreements included new debt covenants. In auditing the debt obligation
in the prior year (before the restructuring), the team established materiality specific to the
financial statement debt account (account level materiality) at a lower amount than overall
financial statement materiality. In planning the audit for the current year, the team plans to
use a similar materiality level. While such a conclusion might be appropriate, what judgment
trap(s) might the team fall into and which step(s) in the judgment process are most likely
affected?
The team needs to understand the terms of the debt restructuring. If the covenants in the new
debt agreements require the company to maintain certain financial ratios (for example, ratio of
assets to liabilities greater than 1.5 to 1), the appropriate account level materiality threshold may
be lower than the threshold used in the prior year when the debt agreement in place only required
the client to meet certain non-financial debt covenants. The traps that the team may have fallen
into include both a rush to solve and a judgment trigger in that they may have considered only
the same approach or alternative as was used in the prior year, even though conditions have
changed in important ways. The step in the judgment process most affected in this scenario is
Step 2, “Consider Alternatives.”
[2] A client is determining its accounting treatment for new types of long-term contracts. Consider
the differences in outcome for the two scenarios below regarding the approach the client and

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

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