Auditing Cases

Instructor Resource Manual

f our th

e d i ti o n

Mark S. Beasley
Frank A. Buckless
Steven M. Glover
Douglas F. Prawitt
do not copy or redistribute
Prentice Hall
Upper Saddle River, New Jersey

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Client Acceptance

S o l u tions inc lu de d in t h is Section

1.1

Ocean Manufacturing, Inc.

. . . . . . . . . . . . . . . . . . . . . . . . . . . .

The New Client Acceptance Decision

Se ct ion

Understanding the Clients Business

and Assessing Risk

S o l u tions inc lu de d in t h is Section

2.1

Your1040Return.com

2.2

Dell Computer Corporation .

2.3

Flash Technologies, Inc.

2.4

Asher Farms Inc.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Evaluating eBusiness Revenue Recognition, Information Privacy,

and Electronic Evidence Issues
. . . . . . . . . . . . . . . . . . . . . . . . .

25

. . . . . . . . . . . . . . . . . . . . . . . . . . . .

39

Evaluation of Client Business Risk

Risk Analysis and Resolution of Client Issues

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

Understanding of Clients Business Environment

Se ct ion

Professional and Ethical Issues

S o l u tions inc lu de d in t h is Section

3.1

A Day in the Life of Brent Dorsey .

3.2

Nathan Johnsons Rental Car Reimbursement . . . . . . . . . . . . . . . . 63

3.3

The Anonymous Caller

3.4

WorldCom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

3.5

Hollinger International

. . . . . . . . . . . . . . . . . . . . . .

59

Staff Auditor Professional Pressures

Solving Ethical DilemmasShould He Pocket the Cash?

. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

65

Recognizing Its a Fraud and Evaluating What to Do

The Story of a Whistleblower

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

Realities of Audit-Related Litigation

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Accounting Fraud and

Auditor Legal Liability

So l u tio n s i nc lu de d in t his Se c tion

4.1

Enron Corporation and Andersen, LLP

4.2

Comptronix Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

4.3

Cendant Corporation .

4.4

Waste Management, Inc.

4.5

Xerox Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

4.6

Phar-Mor, Inc.

. . . . . . . . . . . . . . . . . . .

89

Analyzing the Fall of Two Giants

Identifying Inherent Risk and Control Risk Factors

. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

111

Assessing the Control Environment and Evaluating Risk of

Financial Statement Fraud
. . . . . . . . . . . . . . . . . . . . . . . . . . . .

119

Manipulating Accounting Estimates

Evaluating Risk of Financial Statement Fraud

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

137

Accounting Fraud, Litigation, and Auditor Liability

S e cti on

Internal Control over Financial Reporting

So l u tio n s i nc lu de d in t his Se c tion

ii

5.1

Simply Steam, Co.

5.2

Easy Clean, Co.

5.3

Red Bluff Inn & Caf . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165

5.4

St. James Clothiers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169

5.5

Collins Harp Enterprises

5.6

Sarbox Scooter, Inc. .

5.7

Socit Gnrale

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

155

Evaluation of Internal Control Environment

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

155

Evaluation of Internal Control Environment

Establishing Effective Internal Control in a Small Business

Evaluation of Manual and IT-Based Sales Accounting System Risks

. . . . . . . . . . . . . . . . . . . . . . . . . . .

177

Recommending IT Systems Development Controls

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

185

Scoping and Evaluation Judgments in the Audit of Internal

Control over Financial Reporting
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

195

How a Low-Risk Trading Area Caused a $7.2 Billion Loss

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Table
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con t e n t s

The Impact of Information Technology

S o l u tions inc lu de d in t h is Section

6.1

Harley-Davidson, Inc.

6.2

Jacksonville Jaguars .

. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

207

Identifying eBusiness Risks and Related Assurance Services for

the eBusiness Marketplace
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

215

Evaluating IT Benefits and Risks and Identifying Trust Services

Opportunities
Ot he r c ase s t h at d iscuss topics rel ated to this section
2.1 Your1040Return.com . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Evaluating eBusiness Revenue Recognition, Information Privacy,
and Electronic Evidence Issues
5.4

5.5

9.2

Se ct ion

St. James Clothiers

. . . . . . . . . . . . . . . . . . . . . . . . . . . .

169

Evaluation of Manual and IT-Based Sales Accounting System Risks

Collins Harp Enterprises

. . . . . . . . . . . . . . . . . . . . . . . . .

177

Recommending IT Systems Development Controls

Henrico Retail, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279

Understanding the IT Accounting System and Identifying Audit
Evidence for Retail Sales

Planning Materiality

S o l u tions inc lu de d in t h is Section

7.1

Anne Aylor, Inc.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

229

Determination of Planning Materiality and Tolerable Misstatement

Ot he r c ase s t h at d iscuss topics rel ated to this section
5.6 Sarbox Scooter, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185

Scoping and Evaluation Judgments in the Audit of Internal
Control over Financial Reporting

12.1

12.2

EyeMax Corporation

. . . . . . . . . . . . . . . . . . . . . . . . . . .

369

Evaluation of Audit Differences

Auto Parts, Inc.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

379

Considering Materiality When Evaluating Accounting Policies

and Footnote Disclosures

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Analytical Procedures

So l u tio n s i nc lu de d in t his Se c tion

8.1

Laramie Wire Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . 239

8.2

Northwest Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245

8.3

Burlingham Bees

Using Analytical Procedures in Audit Planning

Developing Expectations for Analytical Procedures

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

251

Using Analytical Procedures as Substantive Tests

O th e r c ase s t h at disc uss topics rel ated to this section
1.1 Ocean Manufacturing, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . 3

The New Client Acceptance Decision
2.3 Flash Technologies, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . 39

Risk Analysis and Resolution of Client Issues

S e cti on

Auditing Cash and Revenues

So l u tio n s i nc lu de d in t his Se c tion

9.1

Wallys Billboard & Sign Supply

9.2

Henrico Retail, Inc.

9.3

Longeta Corporation

9.4

Bud's Big Blue Manufacturing

. . . . . . . . . . . . . . . . . . . . . . .

259

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

279

The Audit of Cash

Understanding the IT Accounting System and Identifying Audit

Evidence for Retail Sales
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

285

Auditing Revenue Contracts

. . . . . . . . . . . . . . . . . . . . . . . .

291

Accounts Receivable Confirmations

O th e r c ase s t h at disc uss topics rel ated to this section

8.2 Northwest Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245

Developing Expectations for Analytical Procedures
8.3 Burlingham Bees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251

Using Analytical Procedures as Substantive Tests

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Se ct ion

10

Table

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con t e n t s

Planning and Performing Audit Procedures

in the Revenue and Expenditure Cycles
An Audit Simulation

S o l u tions inc lu de d in t h is Section

10.1 Southeast Shoe Distributor, Inc. . . . . . . . . .

Identification of Tests of Controls for the Revenue Cycle
(Sales and Cash Receipts)
10.2 Southeast Shoe Distributor, Inc. . . . . . . . . .

Identification of Substantive Tests for the Revenue Cycle
(Sales and Cash Receipts)

. . . . . . . . . . . . . .

299

. . . . . . . . . . . . . .

309

10.3 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . .

Selection of Audit Tests and Risk Assessment for the Revenue Cycle
(Sales and Cash Receipts)

. . . . . . . . .

319

. . . . . . . . . . .

333

. . . . . . . . . . . . .

347

10.4 Southeast Shoe Distributor, Inc. . . . . . . . . . . . .

Performance of Tests of Transactions for the Expenditure Cycle
(Acquisitions and Cash Disbursements)
10.5 Southeast Shoe Distributor, Inc. . . . . . . . . . .

Performance of Tests of Balances for the Expenditure Cycle
(Acquisitions and Cash Disbursements)

Se ct ion

11

Developing and Evaluating

Audit Documentation

S o l u tions inc lu de d in t h is Section

11.1 The Runners Shop . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359

Litigation Support Review of Audit Documentation
for Notes Payable
Ot he r c ase s t h at d iscuss topics rel ated to this section
9.1
Wallys Billboard & Sign Supply . . . . . . . . . . . . . . . . . . . . . 259

The Audit of Cash
9.2
Henrico Retail, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . 279

Understanding the IT Accounting System and Identifying Audit
Evidence for Retail Sales

9.3

9.4

10.1-5

Longeta Corporation

. . . . . . . . . . . . . . . . . . . . . . . . . .

285

Auditing Revenue Contracts

Bud's Big Blue Manufacturing . . . . . . . . . . . . . . . . . . . . . . 291

Accounts Receivable Confirmations

Southeast Shoe Distributor, Inc.

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. . . . . . . . . . . . . . . . . . . .

299

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12

Completing the Audit, Reporting to

Management, and External Reporting

So l u tio n s i nc lu de d in t his Se c tion

12.1 EyeMax Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369

Evaluation of Audit Differences
12.2 Auto Parts, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379

Considering Materiality When Evaluating Accounting Policies
and Footnote Disclosures
12.3 K&K Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 385

Leveraging Audit Findings to Provide Value-Added Insights
12.4 Surfer Dude Duds, Inc. . . . . . . . . .

Considering the Going-Concern Assumption

. . . . . . . . . . . . . . . . . . . .

12.5 Murchison Technologies, Inc. . . . . . . . . . . . . .

Evaluating an Attorneys Response and Identifying the Proper
Audit Report

vi

. . . . . . . . . . . .

391
395

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A l p h a b e t i c
7.1
3.3
2.4
12.2
9.4
8.3
4.3
5.5
4.2
3.1
2.2
5.2
4.1
12.1
2.3
6.1
9.2
3.5
6.2
12.3
8.1
9.3
12.5
3.2
8.2
1.1
4.6
5.3
11.1
5.6
5.1
5.7
10.1
10.2
10.3
10.4
10.5
5.4
12.4
9.1
4.4
3.4
4.5
2.1

C a s e

I n d e x

Anne Aylor, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229

Anonymous Caller, The . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
Asher Farms Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Auto Parts, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379
Bud's Big Blue Manufacturing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291
Burlingham Bees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251
Cendant Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
Collins Harp Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177
Comptronix Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
Day in the Life of Brent Dorsey, A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Dell Computer Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Easy Clean, Co. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155
Enron Corporation and Andersen, LLP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
EyeMax Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369
Flash Technologies, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
Harley-Davidson, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207
Henrico Retail, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279
Hollinger International . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
Jacksonville Jaguars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215
K&K Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 385
Laramie Wire Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239
Longeta Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285
Murchison Technologies, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395
Nathan Johnsons Rental Car Reimbursement . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Northwest Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245
Ocean Manufacturing, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Phar-Mor, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137
Red Bluff Inn & Caf . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165
Runners Shop, The . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359
Sarbox Scooter, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185
Simply Steam, Co. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155
Socit Gnrale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195
Southeast Shoe Distributor, Inc.: Tests of Controls for the Revenue Cycle . . . . . . . . . . . . . 299
Southeast Shoe Distributor, Inc.: Substantive Tests for the Revenue Cycle . . . . . . . . . . . . 309
Southeast Shoe Distributor, Inc.: Audit Tests and Risk Assessment for the Revenue Cycle . . . . 319
Southeast Shoe Distributor, Inc.: Tests of Transactions for the Expenditure Cycle . . . . . . . . . 333
Southeast Shoe Distributor, Inc.: Tests of Balances for the Expenditure Cycle . . . . . . . . . . . 347
St. James Clothiers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169
Surfer Dude Duds, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 391
Wallys Billboard & Sign Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259
Waste Management, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119
WorldCom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
Xerox Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127
Your1040Return.com . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

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P r e fac e
Auditing educators are increasing their emphasis on the development of students 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 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.

The casebook contains a collection of 44 auditing cases that allow the instructor to focus
and deepen students understanding in each of the major activities performed during the conduct
of an audit, from client acceptance to issuance of an audit report. The cases are designed to engage
the students 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 several new authoritative auditing standards, including the
PCAOBs Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting that is
Integrated with an Audit of Financial Statements, the new risk assessment standards issued by the
AICPAs Auditing Standards Board as SAS Nos. 104 through 111, and SAS No. 112, Communicating
Internal Control Related Matters Identified in an Audit, SAS No. 113, Omnibus Statement on Auditing
Standards 2006, and SAS No. 114, The Auditors Communication with Those Charged With Governance.
Several cases require students to gain a clearer understanding of the specific requirements contained
in the SarbanesOxley Act of 2002. Other cases provide additional exposure to the role information
technology in todays assurance environment, including a focus on Trust Services such as SysTrust
and WebTrust. Finally, some cases use excerpts from transcripts of financial statement fraud trails to
illustrate the importance of following audit principles and procedures.

The cases 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. This manual 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.
Please submit any corrections or suggestions to: auditingcases@byu.edu

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f o u r t h

e d i t i o n

updates t o prior c as e s
Cases from the prior edition have been updated to reflect changes in professional standards . Cases
based on events at real companies have been updated to reflect relevant recent developments. The
Anne Aylor case (7.1), has been updated to reflect industry trends, including updated financial
information. Dates in the hypothetical cases have been set in calendar year 2009 with audit procedures
performed for the 2008 fiscal year and/or interim procedures performed for the 2009 fiscal year.

New t o th e fou rth e d ition

The following cases have been added to the fourth edition to expand coverage of audit topics and
provide timely coverage of recent high profile accounting-related events.

2.4

Asher Farms Inc.

3.5

Hollinger International

This case contains excerpts of actual trial transcripts in which the auditor of
Hollinger International addresses several audit concepts including reasonable
assurance, audit committee oversight, and audit documentation.

5.7

Socit Gnrale

9.4

Bud's Big Blue Manufacturing

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

Understanding of Clients Business Environment

In this case students use the PESTLE analysis tool to assess the client's business
environment. Students are encouraged to conduct additional internet research in
order to complete the case. Asher Farms, Inc. is a hypothetical company.
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

Realities of Audit-Related Litigation

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

195

How a Low-Risk Trading Area Caused a $7.2 Billion Loss

This case provides phenomenal details about an actual fraud at France's second
largest bank. The fraud that led to a $7.2 billion loss was perpetrated by one
rogue trader who overrode and eluded internal controls for approximately two
years. The content provides valuable insights for both audit and information
systems courses.
. . . . . . . . . . . . . . . . . . . . . . . .

291

Accounts Receivable Confirmations

This case provides students the opportunity to evaluate the appropriateness and
sufficiency of evidence obtained through confirmations of accounts receivable
balances and to identify any additional procedures that should be performed. Bud's
Big Blue Manufacturing is a hypothetical company.

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Ac 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 casebook.
We would also like to thank Jonathan Liljegren for his excellent work in the design and layout of this
casebook as well as Kierra Kashickey and Judy Leale for their editorial support with this endeavor.
We are grateful to the many research assistants both past and present who have helped write,
revise, and review the cases in this edition. We especially thank Scott Asay, Daniel Strange, and
Devin Williams for their assistance with this latest edition.

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