Andy
Frain is an audit senior of a large public accounting firm who has just been
assigned to the Usher Corporation’s annual audit engagement. Usher is a public
company and has been a client of Frain’s firm for many years. Usher is a
fast-growing business in the commercial construction industry. In reviewing the
fixed asset ledger, Frain discovered a series of unusual accounting changes, in
which the useful lives of assets, depreciated using the straight-line method,
were substantially lowered near the mid-point of the original estimate. For
example, the useful life of one dump truck was changed from 10 to 6 years
during its fifth year of service. Upon further investigation, Andy was told by
Vince Nasab, Usher’s accounting manager, “I don’t really see your problem.
After all, it’s perfectly legal to change an accounting estimate. Besides, our
CEO likes to see big earnings!”
Instructions
Discuss
the issues.
Overview
- UC is a
public company and therefore IFRS is a constraint.
- As
auditor you would want to ensure that changes were made only to provide
relevant and more reliable statements or to refine prior estimates (assuming
more information is now available).
- You would
want to ensure that there was no intent to manage/manipulate the numbers.
- Client infers
that earnings maximization is a goal—this however is not acceptable since
accounting should be neutral.
- Users,
including shareholders and creditors, would want to have high quality
earnings—not earnings propped up by accounting bias.
Analysis and recommendations
- Accounting
estimates are a way of dealing with measurement uncertainty.
- It is
very difficult to estimate the residual values of assets but auditors must
attempt to provide the best estimate and must back it up with evidence.
- Having
said this, remember these are just estimates and estimates change.
- For each
reporting period, management must revisit all estimates and refine them.
- This
happens on a prospective basis.
- The
auditor must ensure that the changes are due to new and better information
being provided/gathered and not due to attempt to manipulate earnings.
- The
auditor must look for and management must provide supporting documentation for
the changes.
- The
auditor must review the information (and be skeptical).
