Deck 13: Waste Management

Question 1

What is auditor independence, and what is its significance to the audit profession? In what ways was Arthur Andersen's independence potentially affected on the Waste Management audit, if any?

Answer 1

Auditor's independence:
Auditor's independence states that the person conducting the audit should be an independent person, independent from its client in judgment and also in presence. The audit must be performed with an independent mind and not under any influence of any person. The auditor must depict the rights things as right and wrong things as wrong. He must not have any beneficial connection or debt owned to any entity to which he is the auditor, as it may force him to give opinion under the influence of the entity.
Arthur Andersen has been the auditor of Waste management for many years, even before waste management became a public company. In addition to the audit service, it also provided non-audit services like business consulting, system consulting, and miscellaneous other services. Moreover, more than half of the fees received from Waste management related to the non-audit services.
Employees of Andersen employees have worked for waste management and were engaged in auditing waste management's financial statement. Furthermore, the officers of Waste management were hired from the Andersen's team, who had previously worked as an auditor at Andersen. The current CAO of waste management was a former audit engagement partner for waste management accounts.
Andersen performs various functions for the client other than an audit. This service includes business consulting, systems consulting, and miscellaneous other services. Providing non-audit services to the client may cause a threat to the independence of the auditor. Andersen may be biased for their client Waste management as Waste management is a significant client, and a significant amount of fees is received from it. The fees received for non-audit services constitute more than half of the total fees, which implies that Andersen will be more focused on non-audit services. This dependence may lead to inappropriate and biased audit opinions.
Moreover, the former partners/employees of Andersen are now the chief employees of waste management, which can influence the auditor's decision. This situation may lead to a familiarity threat in performing the audit with independence. Thus, Andersen must take proper measures to safeguard the audit independence from such a threat and must take proper action to prevent such threats.
Andersen must be independent in judgment and also in presence to build the trust of the external parties on the auditor report. An inappropriate and biased audit opinion can influence the third-party decision and may also lead to legal consequences against Andersen. Hence, Arthur Andersen's independency will potentially affect the audit of waste management.

Question 2

Considering the example in the Waste Management case, explain why a review by the practice director and the audit division head is important in the operations of a CPA firm. In your opinion, was this review effective at Waste Management? Why or why not?

Answer 2

Financial Statements
There are different types of financial statements prepared for accounting purpose like income statements, statement of retained earnings, balance sheet, statement of cash flow etc. These financial statements are used by owners, investors, banks, creditors, stock exchange, financial institutions etc.
Financial statements are governed by accounting principles set by the government bodies like GAAP, SEC and IASB. These accounting principles make accounting reports and financial statements reliable, relevant and comparable. Accounting users can trust the reliable information only and relevance affects the decisions.
GAAP
This is called as general accounting accepted principles that governs the financial accounting practice. Understanding of accounting principles is important to understand and interpret financial statements. Information based on GAAP are reliable, relevant and comparable. Accounting users can trust the reliable information only and relevance affects the decisions. Accounting users can differentiate the organizations with the help of comparable information.
Review of audit report by practice head and audit division head
Review of audit report in a CPA firm by practice head and audit division head is important because they are also responsible for findings stated in the audit report and they need to read the audit findings for its depth, consistency and issues reported. Head of audit division or practice head need to evaluate the impact of serious audit findings, if any, that could qualify the audit report and ensure that audit reports state the facts observed during audits.
In case of WM company review by audit practice director and audit division head was not effective at all because CAP firm was issuing unqualified audit report despite of major irregularities in the financial statements. Recommendations for correction the financial statements like depreciation amount adjustment etc., were not followed by WM company and CPA firm continued to issue unqualified audit reports.
Hence, review by audit practice director and suit division head was not effective for WM company.

Question 3

Explain what is meant by an auditor's proposed adjusting journal entries (PAJEs). Do you believe that Andersen's final decision regarding the PAJE's was appropriate under the circumstances? Would your opinion change if you knew that all of the adjustments were based on subjective differences (such as a difference in the estimate of the allowance for doubtful accounts) as compared to objective differences (such as a difference in the account receivable balance of their biggest customer)?

Answer 3

Financial Statements
There are different types of financial statements prepared for accounting purpose like income statements, statement of retained earnings, balance sheet, statement of cash flow etc. These financial statements are used by owners, investors, banks, creditors, stock exchange, financial institutions etc.
Financial statements are governed by accounting principles set by the government bodies like GAAP, SEC and IASB. These accounting principles make accounting reports and financial statements reliable, relevant and comparable. Accounting users can trust the reliable information only and relevance affects the decisions.
GAAP
This is called as general accounting accepted principles that governs the financial accounting practice. Understanding of accounting principles is important to understand and interpret financial statements. Information based on GAAP are reliable, relevant and comparable. Accounting users can trust the reliable information only and relevance affects the decisions. Accounting users can differentiate the organizations with the help of comparable information.
Proposed adjustment journal entries (PAJEs)
These were adjustment entries proposed by auditing firm to correct the current and prior period's misstatements in the financial statements of WM company. These PAJEs were amounting to $128 million and would have reduced the net income before specified items of WM company by 12%.
Final decision of auditing firm was not appropriate at all because auditing firm supported WM company in misstating the accounting figures in financial statements. Audit division head and practice head of auditing firm determined that misstatements were not material which was incorrect. They further suggested that WM company should change their accounting practices to avoid such misstatements and PAJEs in future. Auditing firm prepared summary of action steps to reduce the amount of PAJEs going forward which is not acceptable and completely unprofessional and unethical.
It would not have made any difference even if all adjustments were based on subjective difference i.e. estimate for allowance for doubt debts because accounting standards and principles clearly defines as to how to estimate allowances for doubtful debts, so that financial statements correct reflects the true and fair view if financial position. It heslp to estimate the net amount receivable and expected bad debts in future.
Hence, it would not have made any difference even if all adjustments were based on subjective difference.

Question 4

Refer to Sections 203 and 206 of SARBOX. How would these sections of the law have impacted the Waste Management audit? Do you believe that these sections are needed? Why or why not?

Question 5

Consider the principles, assumptions, and constraints of Generally Accepted Accounting Principles (GAAP). Define the matching principle and explain why it is important to users of financial statements.

Question 6

Based on the case information provided, describe specifically how Waste Management violated the matching principle.

Question 7

Consult Paragraph 2 and Paragraph A5 (in Appendix A) of PCAOB Auditing Standard No. 5. Do you believe that Waste Management had established an effective system of internal control over financial reporting related to the depreciation expense recorded in its financial statements? Why or why not?

Question 8

Under what circumstances is a company allowed to change the useful life and salvage value of its fixed assets under GAAP? As an auditor, what type of evidence would you want to examine to determine whether Waste Management's decision to change the useful life and salvage value of its assets was appropriate under GAAP?

Question 9

Consider the principles, assumptions, and constraints of Generally Accepted Accounting Principles (GAAP). What is the specific definition of an asset?

Question 10

Consider the practices of basketing and bundling. Briefly explain why each practice is not appropriate under GAAP.

Question 11

Describe why netting would be effective for Waste Management's management team when trying to cover up their fraudulent behavior.

Question 12

As an auditor, what type of evidence would allow you to detect whether your client was engaging in behaviors designed to mask fraud (such as basketing,, bundling, or netting)?

Question 13

In your own words, explain what is meant by a top-side adjusting journal entry. If you were auditing Waste Management, what type of documentary evidence would you require to evaluate the propriety of such a top-side journal entry?

Question 14

Consult Paragraph 14 of PCAOB Auditing Standard No. 5. Based on the case information, do you think this paragraph relates to the use of top-side adjusting journal entries at an audit client like Waste Management? Why or why not?

Question 15

Consult Paragraphs 26-27 of PCAOB Auditing Standard No. 5. Do you believe that the period-end financial reporting process should always be evaluated by auditors as a significant and material process during an audit of internal control? Why or why not?

Question 16

Consult Paragraphs.58-.60 of AU Section 316. Identify one specific control procedure that could prevent or detect a misstatement related to a top-side adjusting journal entry.

Question 17

Consult Paragraphs.07-.08 of AU Section 316. Based on your understanding of fraud risk assessment, what three conditions are likely to be present when fraud occurs (the fraud triangle)? Based on the information provided in the case, which condition was most prevalent at Waste Management, and why?

Question 18

Consult Paragraph 69 of PCAOB Auditing Standard No. 5 and Sections 204 and 301 of SARBOX. What is the role of the audit committee in the financial reporting process? Do you believe that an audit committee can be effective in providing oversight of a management team such as that of Waste Management ?

Question 19

Consult Sections 302 and 305 and Title IX of SARBOX. Do you believe that these provisions will help to deter fraudulent financial reporting by a top management group such as that of Waste Management? Why or why not?

Question 20

Consider the role of the Waste Management employee who was responsible for calculating depreciation expense and recording the proper amount in the financial statements. Assuming the employee knew that the consolidating entries in the fourth quarter recorded by upper management were fraudulent, do you believe that the employee had a responsibility to report the behavior to the audit committee. Why or why not?

Question 21

Consider the decision by CFO James Koenig and Corporate Controller Thomas Hau to phase in the new GAAP method to capitalize interest expense over three years. Do you believe that this decision was in the best interests of the shareholders in the long run? Why or why not?