Deck 35: Waste Management: Top-Side Adjusting Journal Entries

Question 1

Consult Paragraphs 14-15 of PCAOB Auditing Standard No. 13. If you were auditing Waste Management, what type of documentary evidence would you require to evaluate the propriety of a top-side adjusting journal entry?

Answer 1

Public Company Accounting Oversight Board (PCAOB) is a private-sector non-profit organization created by the Sarbanes-Oxley Act of 2002 (SARBOX)
PCAOB is responsible for overseeing the audits of public companies and protecting investor's interest.
Auditing Standard no. 13 deals with auditor's response to the risk of material misstatement.
Paragraph 14 and paragraph 15 of the accounting standard 13 highlights the audit procedures to be followed in the cause of fraud risk pertaining to top side adjusting journal entries.
Top side adjusting journal entries are the adjustments made before preparation of financial statement. Such adjustments are usually not posted through journal entries or ledger posting. Top side adjusting journal entries are usually made by top management.
Documents types/audit procedures listed below will be followed by the auditor to assess the propriety of a top-sided adjusting journal entry.
1. Policies and procedures relating to top-sided journal entries.
2. Interviews with the top management.
3. Any extraordinary transactions at the year-end/end of reporting period.
4. Evidence for any suspicious transaction.

Question 2

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 in any way? Why or why not?

Answer 2

Paragraph #14 of Auditing Standard #5 focused on the importance of auditors utilizing the results of their fraud risk assessments as part of the audit.  Specifically, according to the paragraph, "the auditor should evaluate whether the company's controls sufficiently address identified risks of material misstatement due to fraud and controls intended to address the risk of management override of other controls."  Since top-side entries are a mechanism used by upper managers to circumvent the internal control system, paragraph #14 of Standard No. 5 clearly identifies the danger of unusual journal entries and entries made late in the reporting process explicitly, in the standard.
At Waste Management, the management team was improperly overriding internal controls by making fraudulent top-side adjusting entries.  The entries had no economic substance.  Interestingly, the operating groups were not even aware of the adjusting entries that were being attributed to their operating groups.   As such, they were being used as a way for internal control to be circumvented, essentially by management override.

Question 3

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?

Answer 3

Paragraphs #26-27 of Standard No. 5 highlight the importance for auditors to understand and evaluate the period-end financial reporting process at a detailed level.  Indeed, according to paragraph #26, "because of its importance to financial reporting and to the auditor's opinions on internal control over financial reporting and the financial statements, the auditor must evaluate the period-end financial reporting process. The period-end financial reporting process includes the following:
• Procedures used to enter transaction totals into the general ledger;
• Procedures related to the selection and application of accounting policies;
• Procedures used to initiate, authorize, record, and process journal entries
in the general ledger;
• Procedures used to record recurring and nonrecurring adjustments to the
annual and quarterly financial statements; and
• Procedures for preparing annual and quarterly financial statements and
related disclosures."
Paragraph # 27 describes what the auditor should evaluate when obtaining an understanding and evaluating the period-end process.  Specifically, "As part of evaluating the period-end financial reporting process, the auditor should assess:
• Inputs, procedures performed, and outputs of the processes the company
uses to produce its annual and quarterly financial statements;
• The extent of information technology ("IT") involvement in the period-end
financial reporting process;
• Who participates from management;
• The locations involved in the period-end financial reporting process;
• The types of adjusting and consolidating entries; and
• The nature and extent of the oversight of the process by management, the
board of directors, and the audit committee.
 ?The period-end financial reporting process should always be a significant process in the audit of internal control since many frauds can occur at this point of the process, especially if a company is falling short of the targets and/or projections set by the company and/or the analysts.  It is also important to understand the period-end financial reporting process in detail to ensure that no one manager has too much power to override controls and make material adjustments to the financial statements.  As a result, it should always be considered a significant process since the understanding and evaluation of the process has such a large impact on the financial reporting process.

Question 4

Consult Paragraphs 71-72 of PCAOB Auditing Standard No. 12. Identify one specific control procedure that could be designed to prevent or detect a misstatement related to a top-side adjusting journal entry.