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Newport Soup Inc.: An interactive inherent risk assessment case
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J. of Acc. Ed. j o u r n a l h o m e p a g e : w w w. e l s e v i e r. c o m / l o c a t e / j a c c e d u
Newport Soup Inc.: An interactive inherent risk assessment case Michael Cipriano a, Erin L. Hamilton b, Scott D. Vandervelde c,* a
James Madison University, Harrisonburg, VA, USA University of Nevada, Las Vegas, NV, USA c Moore School of Business, University of South Carolina, Columbia, SC, USA b
A R T I C L E
I N F O
Article history: Received 20 November 2015 Revised 25 July 2016 Accepted 30 July 2016 Available online Keywords: Inherent risk Audit planning Audit risk model Interactive role-play cases
A B S T R A C T
In this role-play case, you will assume the role of an auditor who must gather relevant information about your client and assess inherent risk for six financial statement accounts. To initiate the process of understanding your client’s business, you must email professional inquiries to the “client” (a role played by your instructor) and “ask the right questions” to acquire the information necessary to assess inherent risk. Ultimately, you are asked to prepare a professional memo documenting your assessment of inherent risk for six account balances as part of the audit planning process. An important component of the case is the performance of analytical procedures, which you must interpret using your understanding of the company and the industry in which it operates. © 2016 Elsevier Ltd. All rights reserved.
1. Introduction It is November 20X6, and you are part of the audit team that is performing various audit planning procedures for the audit of the financial statements of Newport Soup, Inc. (NSI), as of December 31, 20X6.1 NSI makes soups and sells them in the United States (US) and all around the world. After years of losing popularity domestically, the US Department of Agriculture (USDA) reports that soup has made a comeback. Evidence of the comeback is observed by a ten percent increase in soup consumption in
* Corresponding author. Fax: +803 777 0712. E-mail address: [email protected] (S.D. Vandervelde). 1 For a client with a December 31st year-end, audit planning procedures (i.e., assessment of audit risk, testing of internal controls, etc.) typically begin in the summer, and often continue into the fall. In rare instances, planning procedures may even persist up to December. Additionally, various circumstances may cause audit procedures to be delayed, in which case, initial planning may begin later in the year than usual. http://dx.doi.org/10.1016/j.jaccedu.2016.07.002 0748-5751/© 2016 Elsevier Ltd. All rights reserved.
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Table 1 Unaudited balances as of September 30, 20X6, Newport Soup, Inc. Sales revenue Cost of goods sold Accounts receivable Less: Allowance for doubtful accounts Net accounts receivable Inventory Less: Reserve for spoilage Net inventory
$2,325,000 $1,453,125 $1,200,000 ($50,000) $1,150,000 $200,000 ($10,000) $190,000
Table 2 Audited balances as of December 31, 20X5, Newport Soup, Inc. Sales revenue Cost of goods sold Accounts receivable Less: Allowance for doubtful accounts Net accounts receivable Inventory Less: Reserve for spoilage Net inventory
$2,400,000 $1,500,000 $800,000 ($50,000) $750,000 $100,000 ($5,000) $95,000
20X6 relative to 20X5. While end consumers of NSI’s soup are individuals, the bulk of NSI sales are to grocery, department and convenience stores. Three of NSI’s most significant grocery store customers are Hammis Fleeter, Pubticks and Alexis Foods. Table 1 contains six account balances as reported in NSI’s September 30, 20X6 un-audited financial statements. Table 2 contains the balances as reported in NSI’s 20X5 audited financial statements. NSI has never had to restate its financial statements and has a reputation for having a fairly ethical management team. Top management (i.e., CEO, CFO) receives base salaries and bonuses that are triggered by NSI’s ability to grow sales and meet Wall Street analysts’ earnings per share (EPS) expectations. NSI has met or beaten analysts’ EPS forecasts in only five of the last 12 quarters. 2. Inherent risk assessment To help perform high quality inherent risk (IR) assessments, the Public Company Accounting Oversight Board (PCAOB) provides guidance within Auditing Standard (AS) 2110 (Public Company Accounting Oversight Board (PCAOB), 2010a) regarding factors that auditors should consider when assessing IR. In performing your risk assessment and writing your memo, you should follow the guidance below from PCAOB AS 2110 and read the standard available at www.pcaob.org: 1. Obtain an understanding of the company, its primary products, the industry in which the company operates, and its competitive standing within this industry (PCAOB (2010a) AS 2110, Paragraphs .07 and .09). 2. Evaluate the characteristics and incentives of management, including incentives resulting from management’s compensation structure and analysts’ earnings expectations (PCAOB (2010a) AS 2110, Paragraph .17). 3. Obtain an understanding of recent developments within the company and its industry (e.g., by talking with management and reading news articles and press releases) and analyze the related business risks (PCAOB (2010a) AS 2110, Paragraphs .11 and .15). 4. Obtain an understanding of the financial accounting principles associated with each account balance and the resulting effect on the complexity or subjectivity of the account (PCAOB (2010a) AS 2110, Paragraphs .12–.13). Please cite this article in press as: Michael Cipriano, Erin L. Hamilton, Scott D. Vandervelde, Newport Soup Inc.: An interactive inherent risk assessment case, J. of Acc. Ed. (2016), doi: 10.1016/j.jaccedu.2016.07.002
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5. Perform analytical procedures for each account balance using your understanding of the company and the economic environment in which it operates to form expectations about resulting trends and relationships (PCAOB (2010a) AS 2110, Paragraphs .46–.48). Your trend analyses should include the following comparisons2: • Current year-to-date account balances and financial ratios compared to prior year(s), both in absolute and in common-sized terms. • Trends occurring in one account compared to trends in other, related accounts (e.g., the consistency of changes in sales revenue with changes in other accounts affected by the sales and collection cycle). • Trends occurring in NSI’s account balances and financial ratios compared to the same trends at peer companies in the industry. • Current year-to-date account balances compared to the amount budgeted or expected by the company. 6. Evaluate the complexity of the account balance, taking into consideration the complexity of relevant financial accounting standards and their implementation and complexity of transactions (e.g., non-routine transactions) (PCAOB (2010a) AS 2110, Paragraphs .60 and .71). 7. Evaluate the amount of judgment required on the part of management to arrive at the account balance (PCAOB (2010a) AS 2110, Paragraph .71: PCAOB (2015) AS 2501, Paragraphs .04 and .07). 8. Evaluate the potential for fraud by “brainstorming” how and where fraud is most likely to occur within the company’s financial statements (PCAOB (2010a) AS 2110, Paragraph .52).
3. Requirements Your task is to assess the level of IR associated with six account balances, which include two income statement accounts and four balance sheet accounts. You are to assume that your assessment is taking place in November 20X6 (one month before NSI’s year-end date of December 31, 20X6) as part of the audit planning process. In conjunction with the guidance in step #5 above, one of the first things you should do is roll forward the income statement balances. That can be as easy as multiplying the income statement accounts by 4/3 to project annualized numbers (unless there is a reason to expect some other projection for the annualized amount). You do not need to project annualized numbers for the balance sheet accounts, because those accounts reflect balances as of a certain date rather than activity for the year. Between now and the due date, you should obtain an understanding of IR by reading AS 2110, asking questions, and requesting evidence from a client representative at NSI. Your professor will be playing the role of the client. Your client has several documents that will assist you in your IR assessment. To obtain these documents and any other information about the soup industry and/or NSI, you must email questions to “the client” (i.e., your professor) in a manner that is clear and professional (see Appendix A). While your goal is to obtain all information needed to assess IR, recognize that clients (and professors) are busy, so you should send as few emails as possible to get the information you need. Remember that high-quality IR assessments involve number crunching, critical thinking, and making professional inquiries in order to obtain information. Once you have obtained and evaluated information from the client, you will need to prepare a professional memo that includes an IR assessment for each of the six account balances as reported in NSI’s September 30, 20X6 un-audited financial statements (see Table 1). Keep in mind that certain risks have the potential to affect most, if not all, accounts. You should begin your memo by identifying pervasive risk factors that either increase or decrease the IR of the overall financial statements. Once you have established a baseline level of IR for NSI as a whole, you should then assess IR for each individual account balance. In addition to providing your IR assessment for each account, your memo will also need to provide a detailed explanation of how you arrived at your IR assessments. This IR
2 The trends and account relations identified here are consistent with what is taught in undergraduate auditing text books, such as Messier, Glover and Prawitt (2016, pp. 156–158).
Please cite this article in press as: Michael Cipriano, Erin L. Hamilton, Scott D. Vandervelde, Newport Soup Inc.: An interactive inherent risk assessment case, J. of Acc. Ed. (2016), doi: 10.1016/j.jaccedu.2016.07.002
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assessment and documentation process serves as the starting point for determining the testing needed for the audit (although consideration of testing procedures is beyond the scope of this case). 4. Teaching notes The Newport Soup, Inc. (NSI) case provides students with the opportunity to analyze a rich set of financial and nonfinancial information (from sources both within and outside the client company) to assess inherent risk (IR) for six financial statement accounts.3 Students then write a professional memo that communicates the level of IR assessed for each account as well as detailed explanations for how they arrived at their conclusions using the evidence provided within the case. 4.1. Learning objectives The Newport Soup, Inc. (NSI) case supports two content-based learning objectives and three skillbased learning objectives that are important for auditing students. Both content-based objectives are focused on providing students a greater understanding of the Audit Risk Model. Objective #1: Students will develop an understanding of what inherent risk (IR) is and how it can be assessed using both quantitative and qualitative information. Objective #2: Students will develop an understanding of the difference between IR and control risk (CR) by assessing IR in a setting that is devoid of information about internal controls. With regard to Objective #1, our case closely follows the IR assessment guidance provided within PCAOB Auditing Standard (AS) 2110, which will help students understand the many facets of an effective IR assessment, as prescribed by the PCAOB. Objective #2 fills a void in the current audit curriculum, which has tended to focus exclusively on CR assessment. The Auditing Standards explicitly state that IR is considered “before consideration of any related controls” (PCAOB (2010b) AS 1101 Paragraph .07, emphasis added). By asking students to assess IR in a context-rich setting that excludes any reference to the client’s internal controls, we believe it will be easier for students to understand IR and the importance of considering all possible risks, while avoiding the assumption that internal controls will effectively mitigate those risks. This case also provides students with the opportunity to develop three important skills critical to the audit profession. Objective #3: Students will learn how to gather information from the client. Objective #4: Students will demonstrate professional written communication skills. Objective #5: Students will analyze both financial and non-financial data in order to complete a crucial audit task. With regard to Objective #3, audit practitioners spend a considerable amount of time and effort gathering information from both their clients and secondary sources to complete various tasks during an audit. Knechel (2000, p. 695) calls for the development of “complex, realistic and interactive learning exercises such as cases, role playing, [etc.]…that reflect the challenges of the dynamic environment in 2000 and beyond.” Although most of the available cases for auditing classes provide students with all of the necessary information at the outset, the NSI case requires students to gather a significant amount of information through role-play. With regard to Objective #4, the case requires students to formulate an essential form of audit communication, a memo for the audit work-paper file. Both memos and email inquiries are important and frequently used written communications in the field of auditing. This case provides students with an opportunity to demonstrate various components of professional written communication, such as clear
3 Alternative unaudited balances and case information have been used in several implementations of this case. These are available from the authors upon request along with a grading template for the alternative case.
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and concise writing, well-supported conclusions, correct grammar, and professional tone. Additionally, this case develops students’ ability to analyze both financial and non-financial data to complete an audit task (Objective #5). Similar to audit practice, the case requires students to integrate multiple pieces of evidence (both financial and non-financial), some of which may have conflicting risk implications. Students will need to use their analytical skills to evaluate and integrate the information to arrive at their conclusions. 4.2. Implementation guidance The case is appropriate for use in undergraduate auditing courses and is designed to support the planning and risk assessment component of the curriculum, which tends to be presented during the first third of the semester. We have found the case to be most successful when it is assigned following an initial presentation of the Audit Risk Model, as the case helps to reinforce the understanding of factors that should be considered when assessing IR. The case may be completed by students on an individual basis or assigned as a collaborative project where students work in groups to come to a consensus on their IR assessments and construct a single memo for submission.4 Students are typically given two weeks to (a) gather information, (b) analyze the case information, and (c) write their risk assessment memos. Once cases are submitted, a class discussion can help highlight important takeaways from the case. The case solution provides suggested discussion questions (and answers) that can either be assigned to students or used by the instructor to stimulate in-class discussion. Approximately 40 minutes is typically required for inclass discussion following the case. An additional 30–40 minutes is required to initially hand out and describe the case and to return graded cases to students and discuss the grading rubric. When the case has been implemented in the past, it has been worth 10 percent of the overall course grade. During the case, students play the role of auditors who begin with minimal information and are given a predetermined amount of time to approach the client with questions that trigger the client to provide additional pieces of information.5 All students are initially presented with the general case materials, which include background information and NSI’s current and prior year financial statements (Tables 1 and 2 provided in the case materials). Students then gain access to additional case materials by emailing relevant inquiries and evidence requests to “the client” (a role typically played by the instructor).6 Students are typically given one week to send their emailed evidence requests to the client. At the end of that period, students can no longer make client inquiries. The remaining amount of time allocated for the case (typically one week) is then spent evaluating the evidence that was gathered.7 By requiring students to obtain relevant information via inquiry, they will learn the importance of asking the “right” questions in obtaining needed information from clients. Some cases in auditing texts related to risk assessment require students to analyze data and examine information (e.g., Arens, Elder, & Beasley, 2012; Louwers, Ramsay, Sinason, Strawser, & Thibodeau, 2013; Rittenberg, Johnstone, & Gramling, 2012). What these cases typically do not require, however, is the kind of information gathering that will be necessary once students enter the auditing profession. Exercises with high levels of interactivity such as this one help students better encode skills and knowledge obtained while completing the case for future use in the field (e.g., Cunningham, 1999; Janvrin, 2003; Kiger & Rose, 2004; Quiron & O’Bryan, 2014; Ravenscroft, Buckless, & Hassall, 1999).
4 This case has been used to provide evidence of written communication skills for an AACSB-accredited accounting program. It could also be used as evidence of critical thinking skills for assessment purposes, but has not been done so by the authors. We thank an anonymous reviewer for this suggestion. 5 When completing the case in groups, instructors can decide whether each group should select one representative to communicate with the client or whether all group members should be involved in the inquiry process. 6 The client role could also be played by a graduate student or an accounting professional, if available. 7 In the most recent implementation of the case (with 23 students), students reported a median of 6–10 hours spent working on the case out of class. It took each student, on average, between nine and ten email exchanges with the instructor to obtain his or her information, and the instructor spent approximately 15 minutes per student managing correspondences. Student correspondence could be a task delegated to a graduate assistant, if available.
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Instructors are encouraged to maintain a spreadsheet tracking the pieces of evidence provided to each student (or group).8 The decision of whether a document should be provided in response to a student’s request is left to the discretion of the instructor. Students are not informed of the number of information items available, which is analogous to a risk assessment environment in the real world. Students must consider the types of information necessary to assess IR and construct clear and concise email requests to obtain the relevant information. Once students have obtained all available evidence items, they are informed that their search is over. The quality of students’ IR assessment memos is enhanced (or reduced) by the success (or failure) of the information search.9 4.2.1. Memo format and point allocation The suggested length for the IR assessment memos is 8–10 pages, double-spaced. We have found this length to be reasonable in the past as it gives students approximately one-and-a-half pages to discuss each account. A different memo length may be suggested if desired. For instructors implementing the case in a large class, grading memos for all students may be time consuming. In this case, instructors may prefer to have students complete the case in groups. Alternatively, we provide a Risk Assessment Template in Appendix B that can be completed by students in place of the professional memo requirement. In grading the case, points must be allocated between content, quality of writing, and the information search. Typically, we have allocated 25–30 percent of the points to information search, 55– 60 percent to content quality, and 10–15 percent to writing quality. 4.2.2. Integrating management assertions For instructors who are interested in increasing the difficulty level of the case, an additional implementation option is to require students to identify the management assertions that are affected by each IR factor. Identifying relevant management assertions takes the IR assessment task one step further by having students consider the specific type of risk (e.g., valuation, accuracy, existence) that is created by each factor. This should help students make the connection between the IR factors and what could “go wrong” because of these risk factors. Linking risks to relevant management assertions is a challenging task (even for practicing auditors). Therefore, we recommend that instructors implementing this requirement assign the case later in the semester, once students have become more familiar with management assertions. 5. Case validation and experiential feedback This case has been administered in undergraduate auditing courses by six instructors (including the three authors) at three different universities. The case has been modified over time based on our own experiences as well as feedback obtained from other instructors and students. In the discussion that follows, we provide descriptive data regarding student performance on and perceptions of the case during four separate implementations with a total of 123 students.10
8 One concern with the case is that students will share information obtained from the client with other students. To help combat this concern, instructors can discuss the AICPA Code of Professional Conduct and the importance of client confidentiality prior to assigning the case. This discussion point is also included in the discussion questions in the Solution (American Institute of Certified Public Accountants (AICPA), 2015). Also, by keeping track of the evidence items provided to each student, instructors can identify when students reference in their memo a document that was not appropriately obtained during inquiry. 9 Some instructors may like the information search component of the case, but would prefer that all students have access to all information when assessing IR. If this is the case, instructors can set a deadline by which students must gather all available evidence (failing to do so would result in a grade reduction). At the end of the evidence gathering period, instructors could provide students with all of the available information. Under this approach, students would still be penalized for failing to collect all of the information on their own, but they would benefit from having access to all of the case information when assessing IR. 10 Multiple t-tests confirm that results do not vary across the four implementations (Implementation 1: N = 17, Implementation 2: N = 58; Implementation 3: N = 25, Implementation 4: N = 23). As such, only combined data for all 123 students are reported in Section 5.1.
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Table 3 Information search results (n = 123 students). (A) Number of students obtaining documents (by document type) Document
Obtained
Not obtained
1 (See Fig. S1 of Solution in Appendix S2) 2 (See Fig. S2 of Solution in Appendix S2) 3 (See Fig. S3 of Solution in Appendix S2) 4 (See Fig. S4 of Solution in Appendix S2) 5 (See Fig. S5 of Solution in Appendix S2)
110 (89.4%) 110 (89.4%) 99 (80.5%) 111 (90.2%) 79 (64.2%)
13 (10.6%) 13 (10.6%) 24 (19.5%) 12 (9.8%) 44 (35.8%)
(B) Number of documents obtained (by student) Number of documents obtained
Number (%) of students
5 (All documents) 4 3 2 1 0
54 (43.9%) 0 (0.0%) 55 (44.7%) 8 (6.5%) 5 (4.1%) 1 (0.8%)
5.1. Data on the evidence search process When evaluating the evidence search process, students who successfully obtain all five available evidence items receive full credit, while students who fail to collect one or more documents are penalized. Table 3 provides data on student performance during the evidence search process.11 In Panel A of Table 3, we report the evidence items that were (and were not) obtained by students as a result of their inquiries.12 More than 80 percent of students were successful in obtaining each of the first four evidence items. The least requested document still was obtained by the majority of students (64.2 percent). In Panel B, we report overall student effectiveness at obtaining the available information. The overwhelming majority of students (88.6 percent) were successful at obtaining at least three documents, and 43.9 percent obtained all evidence items. These results indicate that the case materials provide sufficient cues to trigger relevant inquiries for all documents that are available. 5.2. Post-test and student feedback Feedback information was gathered in the most recent implementation with 23 undergraduate auditing students who completed the case on an individual basis. Following the return of graded case memos and in-class discussion, a follow-up assessment (see Appendix C) was administered to gauge whether students’ understanding of IR assessment was improved following the completion of the case.13 Table 4 reports evidence of student performance on the NSI case (Panel A) compared to performance on the follow-up assessment (Panel B). The NSI case contains four pervasive IR factors and 31 accountspecific IR factors. Panel A of Table 4 reveals that students appear to have the most trouble identifying the pervasive risk factors. Out of four pervasive IR factors, students identified 0.55 (13.6 percent) on
11 We used email to receive and store auditor–client interactions, which allowed for the gathering and eventual coding of data on students’ information search processes. We strictly forbade other interactions (i.e., face-to-face, phone, etc.) to ensure the accuracy and completeness of our data. Sample email exchanges between students and instructors are available upon request made to the corresponding author. 12 In evaluating the evidence search process, we have only considered which documents the students were successful at obtaining. Some instructors may choose to grade the content of the email requests as well as to evaluate students’ professional written communication skills. We thank an anonymous reviewer for this suggestion. 13 The follow-up assessment has comprised between 3.3% and 6.6% of students’ total grade in the class. Instructors interested in using the follow-up assessment can assign it as an in- or out-of-class exercise or include it as an exam question. We have tried giving the follow-up assessment before, as well as after, assigning the NSI case and find that students perform significantly better on the instrument when it is given after the NSI case. We interpret these data as evidence that students’ ability to assess IR improves as a result of the NSI case.
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Table 4 IR assessment results – NSI case versus XYZ follow-up assessment. Available factors
Mean (median) factors identified
Percentage of factors identified
4 31 35
0.55 (0.00) 11.02 (11.50) 11.57 (11.50)
13.6% 35.5% 33.0%
1.18 (1.00) 3.09 (3.00) 4.27 (4.00)
59.1% 77.3% 71.2%
(A) NSI case (n = 23 students) Pervasive risk factors Account-specific risk factors Total
(B) XYZ follow-up assessment (n = 23 students) Pervasive risk factorsa Account-specific risk factors Total
2 4 6
a In a single-account analysis (as is the case in the follow-up assessment), the word “pervasive” may seem out of place. However, these are factors that would impact multiple account balances if multiple accounts were present. We maintain usage of the “pervasive” modifier for comparative purposes with the data presented in Panels A and B. The underline values means that the numbers are being added together with the third number in the column being the sum.
average. Furthermore, students successfully identified approximately 11 of the 31 (35.5 percent) accountspecific risk factors. While these results may appear low, the case is very challenging, given that it contains a total of 35 IR factors, some of which are much more difficult to identify than are others. Furthermore, some students do not obtain all of the case information during their evidence searches, which precludes them from identifying some of the risk factors.14 Panel B of Table 4 presents the results of the follow-up assessment, which was administered to the same 23 students who completed the case. The assessment contained two pervasive IR factors and four account-specific IR factors. On average, students identified 1.18 (59.1 percent) of the pervasive risk factors and 3.09 (77.3 percent) of the account-specific factors. This is considerable improvement compared to the NSI case and is likely due in part to the experience students gained completing the NSI case as well as the subsequent in-class discussion, which highlighted aspects of IR assessment that students had previously missed. In general, feedback received from students who have completed the NSI case has been positive. Table 5 reports the results of a survey given to the 23 students who most recently completed the case. We used a 5-point scale ranging from 1 (Strongly Agree) to 5 (Strongly Disagree) (i.e., lower numbers represent greater agreement). Regarding our learning objectives, students indicated that the case increased their understanding of IR (mean of 1.78), how quantitative and qualitative information can be used to assess IR (means of 1.78 and 1.83, respectively) and how IR differs from CR (mean = 1.83). Students also indicated that the case required them to use their analytical skills to evaluate quantitative and qualitative information (mean of 1.35). Finally, students believed that the case increased their professional communication skills (means of 2.04 and 1.83 regarding communicating for requesting information from the client and communicating through constructing memos, respectively). Given that students found the case to be challenging (mean of 1.74), it is not surprising that they were somewhat neutral regarding their level of enjoyment (mean of 2.91), as performing new and difficult tasks, while valuable, can be frustrating for students. The student feedback reported here and the results from the follow-up assessment (reported in Panel B of Table 4) provide evidence that the case’s learning objectives are being met and students’ overall understanding of IR is improved following the completion of the case.
14 While we only report data on the follow-up exercise for the most recent implementation (with 23 students), all of the 123 students included in the case data also completed an additional information acquisition task (related to auditing cash) following the NSI case. We find that, on average, the students’ acquisition of information improved by 10 percentage points on the follow-up cash case. We interpret these data as evidence that students’ information acquisition skills improved as a result of the NSI case.
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Table 5 Post-case survey results (n = 23 students).a Survey question
Mean
Median
Std. dev.
The case increased my understanding of how quantitative factors (i.e., analytical procedures) should be used to assess inherent risk. The case increased my understanding of how qualitative factors (i.e., company and industry risks, complexity and subjectivity of accounts, fraud risk) should be used to assess inherent risk. The case increased my overall understanding of inherent risk. The case increased my understanding of the difference between inherent risk and control risk. The case increased my ability to request information from a client that is needed to complete an audit task in a professional manner. The case increased my ability to construct a memo that documents my analysis in a persuasive, professional manner. The case required me to analyze both financial and non-financial information to assess inherent risk. I found the case assignment to be challenging. I found the case assignment to be interesting and enjoyable.
1.78
2.00
0.67
1.83
2.00
0.78
1.78 1.83 2.04
2.00 2.00 2.00
0.95 0.83 1.19
1.83
2.00
0.78
1.35
1.00
0.71
1.74 2.91
1.00 3.00
0.96 1.08
a When completing the survey, students were given the following instructions: “Please indicate the extent of your agreement with each question regarding the Newport Soup, Inc. case, our subsequent discussion of it and the XYZ follow-up exercise by circling a number from 1 (Strongly Agree) to 5 (Strongly Disagree).”
6. Solution Case solutions are available, on request, from the corresponding author. Acknowledgments This paper has benefitted from the comments of Audrey Gramling, Tim Miller, Bob Ramsay, YiJing Wu, two anonymous reviewers, the Associate Editor and Editor of Journal of Accounting Education, attendees at the South Carolina Association of Educators meeting, and various undergraduate and graduate auditing students at the College of Charleston, University of South Carolina, and the University of South Carolina Upstate. Appendix A Guidance for communication with clients When making inquiries of your clients, the quality of the information you receive will often be a function of the quality of your inquiries. For this case, all of your communication will be via email. As such, these guidelines are specifically prepared to support high-quality email inquiries.
•
•
Edit your emails to eliminate grammar and spelling errors. While no client expects emails from auditors to be perfect, simple mistakes like using “there” instead of “their” can significantly impair a client’s perception of you. Most email software includes spelling and grammar check, but you should also proactively review your emails for errors that the software might not catch (i.e., the aforementioned “there” versus “their” error). When your inquiries are grammatically incorrect, your client may be unable to decipher your request and/or may be less inclined to respond in a complete manner. Use a professional and respectful tone in your emails. Inquiry with audit clients requires sensitivity, especially in an IR assessment task, because the auditor is trying to assess the likelihood that a material misstatement has been made by the client. The use of deferential terms like “please” and “thank you” is obvious, but you should also take special care to use language that is nonthreatening. Accusatory language of any kind is strictly forbidden. If your tone is perceived as being anything less than respectful, your clients will be less likely to respond favorably to your inquiries.
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Ask direct, well-informed questions. If you are trying to elicit a detailed response to your question, you should ask it in a manner that is direct and clear; ambiguity tends to be met with poor responsiveness. For instance, if you merely ask for “information” or “reports” your client will have no idea what you want. However, if you ask for a report by name (i.e., Monthly Sales Report) then your client will know exactly what you want. Additionally, you should ask questions that indicate that you have done an appropriate amount of analysis prior to asking the client. For example, if you are asking about a trend in your client’s revenues, then you should include your calculations of sales growth within your email inquiry. Clients will have little patience for questions to which you should already have the answers. Communications must be respectful of your client’s time. Clients have responsibilities other than answering your questions. The best way to deal with busy clients is to combine your questions into as few emails as possible. Combining your questions into one or two messages reduces the number of disruptions for the client. You should also ask the client your well-informed questions as early as you possibly can. This gives the client time to respond to your request at their convenience. If you need information by Friday, then you should try to request it on Monday or Tuesday. Requests at 5:00pm on Thursday for information you need from a client on Friday morning will likely be met with contempt. By asking for something at the last minute, you imply that your time is more important than your client’s time. On this assignment, if you do not have everything you need by the communicated deadline, then you will not receive it. Your client does not work weekends.
Appendix B Risk assessment template Instructions: Using the following template, describe the risk factors you considered while assessing the level of inherent risk for the account you indicate below. Next to each risk factor, insert a “+” or “−” to indicate whether the item increases or decreases inherent risk. Finally, indicate your overall assessment regarding the level of inherent risk for the account. Name of the account being evaluated: __________________________________ Risk factor description
Inc/dec inherent risk
1. 2. 3. 4. 5. 6. 7. 8.
Overall, the inherent risk for this account is assessed at: _______________________________ Appendix C Post-case assessment instrument (XYZ case) XYZ manufactures and sells electronic equipment. XYZ’s current CEO has an excellent reputation for honest financial reporting, but the company did have to restate its financial statements last year due to a material amount of inappropriate revenue recognition. You are the auditor for XYZ, Inc. You have been assigned to assess the inherent risk (IR) of XYZ’s Inventory Obsolescence Reserve for the current year. The accounting for this reserve is relatively simple to understand. Consider the Inventory Obsolescence Reserve to be similar to the Allowance for Doubtful Accounts. The Allowance for Doubtful Accounts is a contra asset to Accounts Receivable, whereas the Inventory Obsolescence Reserve is a Please cite this article in press as: Michael Cipriano, Erin L. Hamilton, Scott D. Vandervelde, Newport Soup Inc.: An interactive inherent risk assessment case, J. of Acc. Ed. (2016), doi: 10.1016/j.jaccedu.2016.07.002
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contra asset to Inventory. GAAP requires XYZ to have this account to recognize that at least some percentage of its Inventory is obsolete (no longer of value) when it gets to be “too old”. Last year, XYZ turned its inventory every 20.5 days and set an Inventory Obsolescence Reserve equal to 2.0% of Ending Inventory. Current year inventory turnover ratio calculation (based on current year un-audited numbers): Inventory turnover ratio Days to turn inventory
9 40.5 days
Inventory obsolescence reserve calculation (based on current year un-audited numbers): Ending inventory % of inventory Inventory obsolescence reserve
$15,000 ×1.0% =$150
Write a brief memo in which you assess the IR of the $150 Inventory Obsolescence Reserve for the current year based on ALL of the IR factors that an auditor should consider in IR Assessment. Appendix D: Supplementary material Supplementary data to this article can be found online at doi:10.1016/j.jaccedu.2016.07.002. References American Institute of Certified Public Accountants (AICPA) (2015). Code of professional conduct. New York. Arens, A. A., Elder, R. J., & Beasley, M. S. (2012). Auditing and assurance services (14th ed.). Upper Saddle River, NJ: Pearson Prentice Hall. Cunningham, B. M. (1999). Energizing your teaching: a view from deep in the trenches. Issues in Accounting Education, 14, 307–321. Janvrin, D. J. (2003). St. Patrick Company: using role play to examine internal control and fraud detection concepts. Journal of Information Systems, 17(2), 17–39. Kiger, J. E., & Rose, K. M. (2004). Internal control evaluation of a restaurant: a teaching case. Issues in Accounting Education, 19(2), 229–237. Knechel, W. R. (2000). Behavioral research in auditing and its impact on audit education. Issues in Accounting Education, 15(4), 695–712. Louwers, T. J., Ramsay, R. J., Sinason, D. H., Strawser, J. R., & Thibodeau, J. C. (2013). Auditing and assurance services (5th ed.). New York: McGraw-Hill Irwin. Messier, W. F., Glover, S. M., & Prawitt, D. F. (2016). Auditing & assurance services: A systematic approach (10th ed.). New York: McGraw-Hill Education. Public Company Accounting Oversight Board (PCAOB) (2010a). Identifying and assessing risks of material misstatement. Washington, DC. Auditing Standard (AS) 2110. Public Company Accounting Oversight Board (PCAOB) (2010b). Audit risk. Washington, DC. Auditing Standard (AS) 1101. Public Company Accounting Oversight Board (PCAOB) (2015). Auditing accounting estimates. Washington, DC. Auditing Standard (AS) 2501. Quiron, J. J., & O’Bryan, D. W. (2014). The mobile home monster: a forensic case in the use of public records to locate assets. Issues in Accounting Education, 29(2), 371–378. Ravenscroft, S. P., Buckless, F. A., & Hassall, T. (1999). Cooperative learning – a literature guide. Accounting Education, 8(2), 163–176. Rittenberg, L. E., Johnstone, K. J., & Gramling, A. A. (2012). Auditing: A business risk approach (8th ed.). Mason, OH: South-Western, Cengage Learning.
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J. of Acc. Ed. j o u r n a l h o m e p a g e : w w w. e l s e v i e r. c o m / l o c a t e / j a c c e d u
Newport Soup Inc.: An interactive inherent risk assessment case Michael Cipriano a, Erin L. Hamilton b, Scott D. Vandervelde c,* a
James Madison University, Harrisonburg, VA, USA University of Nevada, Las Vegas, NV, USA c Moore School of Business, University of South Carolina, Columbia, SC, USA b
A R T I C L E
I N F O
Article history: Received 20 November 2015 Revised 25 July 2016 Accepted 30 July 2016 Available online Keywords: Inherent risk Audit planning Audit risk model Interactive role-play cases
A B S T R A C T
In this role-play case, you will assume the role of an auditor who must gather relevant information about your client and assess inherent risk for six financial statement accounts. To initiate the process of understanding your client’s business, you must email professional inquiries to the “client” (a role played by your instructor) and “ask the right questions” to acquire the information necessary to assess inherent risk. Ultimately, you are asked to prepare a professional memo documenting your assessment of inherent risk for six account balances as part of the audit planning process. An important component of the case is the performance of analytical procedures, which you must interpret using your understanding of the company and the industry in which it operates. © 2016 Elsevier Ltd. All rights reserved.
1. Introduction It is November 20X6, and you are part of the audit team that is performing various audit planning procedures for the audit of the financial statements of Newport Soup, Inc. (NSI), as of December 31, 20X6.1 NSI makes soups and sells them in the United States (US) and all around the world. After years of losing popularity domestically, the US Department of Agriculture (USDA) reports that soup has made a comeback. Evidence of the comeback is observed by a ten percent increase in soup consumption in
* Corresponding author. Fax: +803 777 0712. E-mail address: [email protected] (S.D. Vandervelde). 1 For a client with a December 31st year-end, audit planning procedures (i.e., assessment of audit risk, testing of internal controls, etc.) typically begin in the summer, and often continue into the fall. In rare instances, planning procedures may even persist up to December. Additionally, various circumstances may cause audit procedures to be delayed, in which case, initial planning may begin later in the year than usual. http://dx.doi.org/10.1016/j.jaccedu.2016.07.002 0748-5751/© 2016 Elsevier Ltd. All rights reserved.
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Table 1 Unaudited balances as of September 30, 20X6, Newport Soup, Inc. Sales revenue Cost of goods sold Accounts receivable Less: Allowance for doubtful accounts Net accounts receivable Inventory Less: Reserve for spoilage Net inventory
$2,325,000 $1,453,125 $1,200,000 ($50,000) $1,150,000 $200,000 ($10,000) $190,000
Table 2 Audited balances as of December 31, 20X5, Newport Soup, Inc. Sales revenue Cost of goods sold Accounts receivable Less: Allowance for doubtful accounts Net accounts receivable Inventory Less: Reserve for spoilage Net inventory
$2,400,000 $1,500,000 $800,000 ($50,000) $750,000 $100,000 ($5,000) $95,000
20X6 relative to 20X5. While end consumers of NSI’s soup are individuals, the bulk of NSI sales are to grocery, department and convenience stores. Three of NSI’s most significant grocery store customers are Hammis Fleeter, Pubticks and Alexis Foods. Table 1 contains six account balances as reported in NSI’s September 30, 20X6 un-audited financial statements. Table 2 contains the balances as reported in NSI’s 20X5 audited financial statements. NSI has never had to restate its financial statements and has a reputation for having a fairly ethical management team. Top management (i.e., CEO, CFO) receives base salaries and bonuses that are triggered by NSI’s ability to grow sales and meet Wall Street analysts’ earnings per share (EPS) expectations. NSI has met or beaten analysts’ EPS forecasts in only five of the last 12 quarters. 2. Inherent risk assessment To help perform high quality inherent risk (IR) assessments, the Public Company Accounting Oversight Board (PCAOB) provides guidance within Auditing Standard (AS) 2110 (Public Company Accounting Oversight Board (PCAOB), 2010a) regarding factors that auditors should consider when assessing IR. In performing your risk assessment and writing your memo, you should follow the guidance below from PCAOB AS 2110 and read the standard available at www.pcaob.org: 1. Obtain an understanding of the company, its primary products, the industry in which the company operates, and its competitive standing within this industry (PCAOB (2010a) AS 2110, Paragraphs .07 and .09). 2. Evaluate the characteristics and incentives of management, including incentives resulting from management’s compensation structure and analysts’ earnings expectations (PCAOB (2010a) AS 2110, Paragraph .17). 3. Obtain an understanding of recent developments within the company and its industry (e.g., by talking with management and reading news articles and press releases) and analyze the related business risks (PCAOB (2010a) AS 2110, Paragraphs .11 and .15). 4. Obtain an understanding of the financial accounting principles associated with each account balance and the resulting effect on the complexity or subjectivity of the account (PCAOB (2010a) AS 2110, Paragraphs .12–.13). Please cite this article in press as: Michael Cipriano, Erin L. Hamilton, Scott D. Vandervelde, Newport Soup Inc.: An interactive inherent risk assessment case, J. of Acc. Ed. (2016), doi: 10.1016/j.jaccedu.2016.07.002
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5. Perform analytical procedures for each account balance using your understanding of the company and the economic environment in which it operates to form expectations about resulting trends and relationships (PCAOB (2010a) AS 2110, Paragraphs .46–.48). Your trend analyses should include the following comparisons2: • Current year-to-date account balances and financial ratios compared to prior year(s), both in absolute and in common-sized terms. • Trends occurring in one account compared to trends in other, related accounts (e.g., the consistency of changes in sales revenue with changes in other accounts affected by the sales and collection cycle). • Trends occurring in NSI’s account balances and financial ratios compared to the same trends at peer companies in the industry. • Current year-to-date account balances compared to the amount budgeted or expected by the company. 6. Evaluate the complexity of the account balance, taking into consideration the complexity of relevant financial accounting standards and their implementation and complexity of transactions (e.g., non-routine transactions) (PCAOB (2010a) AS 2110, Paragraphs .60 and .71). 7. Evaluate the amount of judgment required on the part of management to arrive at the account balance (PCAOB (2010a) AS 2110, Paragraph .71: PCAOB (2015) AS 2501, Paragraphs .04 and .07). 8. Evaluate the potential for fraud by “brainstorming” how and where fraud is most likely to occur within the company’s financial statements (PCAOB (2010a) AS 2110, Paragraph .52).
3. Requirements Your task is to assess the level of IR associated with six account balances, which include two income statement accounts and four balance sheet accounts. You are to assume that your assessment is taking place in November 20X6 (one month before NSI’s year-end date of December 31, 20X6) as part of the audit planning process. In conjunction with the guidance in step #5 above, one of the first things you should do is roll forward the income statement balances. That can be as easy as multiplying the income statement accounts by 4/3 to project annualized numbers (unless there is a reason to expect some other projection for the annualized amount). You do not need to project annualized numbers for the balance sheet accounts, because those accounts reflect balances as of a certain date rather than activity for the year. Between now and the due date, you should obtain an understanding of IR by reading AS 2110, asking questions, and requesting evidence from a client representative at NSI. Your professor will be playing the role of the client. Your client has several documents that will assist you in your IR assessment. To obtain these documents and any other information about the soup industry and/or NSI, you must email questions to “the client” (i.e., your professor) in a manner that is clear and professional (see Appendix A). While your goal is to obtain all information needed to assess IR, recognize that clients (and professors) are busy, so you should send as few emails as possible to get the information you need. Remember that high-quality IR assessments involve number crunching, critical thinking, and making professional inquiries in order to obtain information. Once you have obtained and evaluated information from the client, you will need to prepare a professional memo that includes an IR assessment for each of the six account balances as reported in NSI’s September 30, 20X6 un-audited financial statements (see Table 1). Keep in mind that certain risks have the potential to affect most, if not all, accounts. You should begin your memo by identifying pervasive risk factors that either increase or decrease the IR of the overall financial statements. Once you have established a baseline level of IR for NSI as a whole, you should then assess IR for each individual account balance. In addition to providing your IR assessment for each account, your memo will also need to provide a detailed explanation of how you arrived at your IR assessments. This IR
2 The trends and account relations identified here are consistent with what is taught in undergraduate auditing text books, such as Messier, Glover and Prawitt (2016, pp. 156–158).
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assessment and documentation process serves as the starting point for determining the testing needed for the audit (although consideration of testing procedures is beyond the scope of this case). 4. Teaching notes The Newport Soup, Inc. (NSI) case provides students with the opportunity to analyze a rich set of financial and nonfinancial information (from sources both within and outside the client company) to assess inherent risk (IR) for six financial statement accounts.3 Students then write a professional memo that communicates the level of IR assessed for each account as well as detailed explanations for how they arrived at their conclusions using the evidence provided within the case. 4.1. Learning objectives The Newport Soup, Inc. (NSI) case supports two content-based learning objectives and three skillbased learning objectives that are important for auditing students. Both content-based objectives are focused on providing students a greater understanding of the Audit Risk Model. Objective #1: Students will develop an understanding of what inherent risk (IR) is and how it can be assessed using both quantitative and qualitative information. Objective #2: Students will develop an understanding of the difference between IR and control risk (CR) by assessing IR in a setting that is devoid of information about internal controls. With regard to Objective #1, our case closely follows the IR assessment guidance provided within PCAOB Auditing Standard (AS) 2110, which will help students understand the many facets of an effective IR assessment, as prescribed by the PCAOB. Objective #2 fills a void in the current audit curriculum, which has tended to focus exclusively on CR assessment. The Auditing Standards explicitly state that IR is considered “before consideration of any related controls” (PCAOB (2010b) AS 1101 Paragraph .07, emphasis added). By asking students to assess IR in a context-rich setting that excludes any reference to the client’s internal controls, we believe it will be easier for students to understand IR and the importance of considering all possible risks, while avoiding the assumption that internal controls will effectively mitigate those risks. This case also provides students with the opportunity to develop three important skills critical to the audit profession. Objective #3: Students will learn how to gather information from the client. Objective #4: Students will demonstrate professional written communication skills. Objective #5: Students will analyze both financial and non-financial data in order to complete a crucial audit task. With regard to Objective #3, audit practitioners spend a considerable amount of time and effort gathering information from both their clients and secondary sources to complete various tasks during an audit. Knechel (2000, p. 695) calls for the development of “complex, realistic and interactive learning exercises such as cases, role playing, [etc.]…that reflect the challenges of the dynamic environment in 2000 and beyond.” Although most of the available cases for auditing classes provide students with all of the necessary information at the outset, the NSI case requires students to gather a significant amount of information through role-play. With regard to Objective #4, the case requires students to formulate an essential form of audit communication, a memo for the audit work-paper file. Both memos and email inquiries are important and frequently used written communications in the field of auditing. This case provides students with an opportunity to demonstrate various components of professional written communication, such as clear
3 Alternative unaudited balances and case information have been used in several implementations of this case. These are available from the authors upon request along with a grading template for the alternative case.
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and concise writing, well-supported conclusions, correct grammar, and professional tone. Additionally, this case develops students’ ability to analyze both financial and non-financial data to complete an audit task (Objective #5). Similar to audit practice, the case requires students to integrate multiple pieces of evidence (both financial and non-financial), some of which may have conflicting risk implications. Students will need to use their analytical skills to evaluate and integrate the information to arrive at their conclusions. 4.2. Implementation guidance The case is appropriate for use in undergraduate auditing courses and is designed to support the planning and risk assessment component of the curriculum, which tends to be presented during the first third of the semester. We have found the case to be most successful when it is assigned following an initial presentation of the Audit Risk Model, as the case helps to reinforce the understanding of factors that should be considered when assessing IR. The case may be completed by students on an individual basis or assigned as a collaborative project where students work in groups to come to a consensus on their IR assessments and construct a single memo for submission.4 Students are typically given two weeks to (a) gather information, (b) analyze the case information, and (c) write their risk assessment memos. Once cases are submitted, a class discussion can help highlight important takeaways from the case. The case solution provides suggested discussion questions (and answers) that can either be assigned to students or used by the instructor to stimulate in-class discussion. Approximately 40 minutes is typically required for inclass discussion following the case. An additional 30–40 minutes is required to initially hand out and describe the case and to return graded cases to students and discuss the grading rubric. When the case has been implemented in the past, it has been worth 10 percent of the overall course grade. During the case, students play the role of auditors who begin with minimal information and are given a predetermined amount of time to approach the client with questions that trigger the client to provide additional pieces of information.5 All students are initially presented with the general case materials, which include background information and NSI’s current and prior year financial statements (Tables 1 and 2 provided in the case materials). Students then gain access to additional case materials by emailing relevant inquiries and evidence requests to “the client” (a role typically played by the instructor).6 Students are typically given one week to send their emailed evidence requests to the client. At the end of that period, students can no longer make client inquiries. The remaining amount of time allocated for the case (typically one week) is then spent evaluating the evidence that was gathered.7 By requiring students to obtain relevant information via inquiry, they will learn the importance of asking the “right” questions in obtaining needed information from clients. Some cases in auditing texts related to risk assessment require students to analyze data and examine information (e.g., Arens, Elder, & Beasley, 2012; Louwers, Ramsay, Sinason, Strawser, & Thibodeau, 2013; Rittenberg, Johnstone, & Gramling, 2012). What these cases typically do not require, however, is the kind of information gathering that will be necessary once students enter the auditing profession. Exercises with high levels of interactivity such as this one help students better encode skills and knowledge obtained while completing the case for future use in the field (e.g., Cunningham, 1999; Janvrin, 2003; Kiger & Rose, 2004; Quiron & O’Bryan, 2014; Ravenscroft, Buckless, & Hassall, 1999).
4 This case has been used to provide evidence of written communication skills for an AACSB-accredited accounting program. It could also be used as evidence of critical thinking skills for assessment purposes, but has not been done so by the authors. We thank an anonymous reviewer for this suggestion. 5 When completing the case in groups, instructors can decide whether each group should select one representative to communicate with the client or whether all group members should be involved in the inquiry process. 6 The client role could also be played by a graduate student or an accounting professional, if available. 7 In the most recent implementation of the case (with 23 students), students reported a median of 6–10 hours spent working on the case out of class. It took each student, on average, between nine and ten email exchanges with the instructor to obtain his or her information, and the instructor spent approximately 15 minutes per student managing correspondences. Student correspondence could be a task delegated to a graduate assistant, if available.
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Instructors are encouraged to maintain a spreadsheet tracking the pieces of evidence provided to each student (or group).8 The decision of whether a document should be provided in response to a student’s request is left to the discretion of the instructor. Students are not informed of the number of information items available, which is analogous to a risk assessment environment in the real world. Students must consider the types of information necessary to assess IR and construct clear and concise email requests to obtain the relevant information. Once students have obtained all available evidence items, they are informed that their search is over. The quality of students’ IR assessment memos is enhanced (or reduced) by the success (or failure) of the information search.9 4.2.1. Memo format and point allocation The suggested length for the IR assessment memos is 8–10 pages, double-spaced. We have found this length to be reasonable in the past as it gives students approximately one-and-a-half pages to discuss each account. A different memo length may be suggested if desired. For instructors implementing the case in a large class, grading memos for all students may be time consuming. In this case, instructors may prefer to have students complete the case in groups. Alternatively, we provide a Risk Assessment Template in Appendix B that can be completed by students in place of the professional memo requirement. In grading the case, points must be allocated between content, quality of writing, and the information search. Typically, we have allocated 25–30 percent of the points to information search, 55– 60 percent to content quality, and 10–15 percent to writing quality. 4.2.2. Integrating management assertions For instructors who are interested in increasing the difficulty level of the case, an additional implementation option is to require students to identify the management assertions that are affected by each IR factor. Identifying relevant management assertions takes the IR assessment task one step further by having students consider the specific type of risk (e.g., valuation, accuracy, existence) that is created by each factor. This should help students make the connection between the IR factors and what could “go wrong” because of these risk factors. Linking risks to relevant management assertions is a challenging task (even for practicing auditors). Therefore, we recommend that instructors implementing this requirement assign the case later in the semester, once students have become more familiar with management assertions. 5. Case validation and experiential feedback This case has been administered in undergraduate auditing courses by six instructors (including the three authors) at three different universities. The case has been modified over time based on our own experiences as well as feedback obtained from other instructors and students. In the discussion that follows, we provide descriptive data regarding student performance on and perceptions of the case during four separate implementations with a total of 123 students.10
8 One concern with the case is that students will share information obtained from the client with other students. To help combat this concern, instructors can discuss the AICPA Code of Professional Conduct and the importance of client confidentiality prior to assigning the case. This discussion point is also included in the discussion questions in the Solution (American Institute of Certified Public Accountants (AICPA), 2015). Also, by keeping track of the evidence items provided to each student, instructors can identify when students reference in their memo a document that was not appropriately obtained during inquiry. 9 Some instructors may like the information search component of the case, but would prefer that all students have access to all information when assessing IR. If this is the case, instructors can set a deadline by which students must gather all available evidence (failing to do so would result in a grade reduction). At the end of the evidence gathering period, instructors could provide students with all of the available information. Under this approach, students would still be penalized for failing to collect all of the information on their own, but they would benefit from having access to all of the case information when assessing IR. 10 Multiple t-tests confirm that results do not vary across the four implementations (Implementation 1: N = 17, Implementation 2: N = 58; Implementation 3: N = 25, Implementation 4: N = 23). As such, only combined data for all 123 students are reported in Section 5.1.
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Table 3 Information search results (n = 123 students). (A) Number of students obtaining documents (by document type) Document
Obtained
Not obtained
1 (See Fig. S1 of Solution in Appendix S2) 2 (See Fig. S2 of Solution in Appendix S2) 3 (See Fig. S3 of Solution in Appendix S2) 4 (See Fig. S4 of Solution in Appendix S2) 5 (See Fig. S5 of Solution in Appendix S2)
110 (89.4%) 110 (89.4%) 99 (80.5%) 111 (90.2%) 79 (64.2%)
13 (10.6%) 13 (10.6%) 24 (19.5%) 12 (9.8%) 44 (35.8%)
(B) Number of documents obtained (by student) Number of documents obtained
Number (%) of students
5 (All documents) 4 3 2 1 0
54 (43.9%) 0 (0.0%) 55 (44.7%) 8 (6.5%) 5 (4.1%) 1 (0.8%)
5.1. Data on the evidence search process When evaluating the evidence search process, students who successfully obtain all five available evidence items receive full credit, while students who fail to collect one or more documents are penalized. Table 3 provides data on student performance during the evidence search process.11 In Panel A of Table 3, we report the evidence items that were (and were not) obtained by students as a result of their inquiries.12 More than 80 percent of students were successful in obtaining each of the first four evidence items. The least requested document still was obtained by the majority of students (64.2 percent). In Panel B, we report overall student effectiveness at obtaining the available information. The overwhelming majority of students (88.6 percent) were successful at obtaining at least three documents, and 43.9 percent obtained all evidence items. These results indicate that the case materials provide sufficient cues to trigger relevant inquiries for all documents that are available. 5.2. Post-test and student feedback Feedback information was gathered in the most recent implementation with 23 undergraduate auditing students who completed the case on an individual basis. Following the return of graded case memos and in-class discussion, a follow-up assessment (see Appendix C) was administered to gauge whether students’ understanding of IR assessment was improved following the completion of the case.13 Table 4 reports evidence of student performance on the NSI case (Panel A) compared to performance on the follow-up assessment (Panel B). The NSI case contains four pervasive IR factors and 31 accountspecific IR factors. Panel A of Table 4 reveals that students appear to have the most trouble identifying the pervasive risk factors. Out of four pervasive IR factors, students identified 0.55 (13.6 percent) on
11 We used email to receive and store auditor–client interactions, which allowed for the gathering and eventual coding of data on students’ information search processes. We strictly forbade other interactions (i.e., face-to-face, phone, etc.) to ensure the accuracy and completeness of our data. Sample email exchanges between students and instructors are available upon request made to the corresponding author. 12 In evaluating the evidence search process, we have only considered which documents the students were successful at obtaining. Some instructors may choose to grade the content of the email requests as well as to evaluate students’ professional written communication skills. We thank an anonymous reviewer for this suggestion. 13 The follow-up assessment has comprised between 3.3% and 6.6% of students’ total grade in the class. Instructors interested in using the follow-up assessment can assign it as an in- or out-of-class exercise or include it as an exam question. We have tried giving the follow-up assessment before, as well as after, assigning the NSI case and find that students perform significantly better on the instrument when it is given after the NSI case. We interpret these data as evidence that students’ ability to assess IR improves as a result of the NSI case.
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Table 4 IR assessment results – NSI case versus XYZ follow-up assessment. Available factors
Mean (median) factors identified
Percentage of factors identified
4 31 35
0.55 (0.00) 11.02 (11.50) 11.57 (11.50)
13.6% 35.5% 33.0%
1.18 (1.00) 3.09 (3.00) 4.27 (4.00)
59.1% 77.3% 71.2%
(A) NSI case (n = 23 students) Pervasive risk factors Account-specific risk factors Total
(B) XYZ follow-up assessment (n = 23 students) Pervasive risk factorsa Account-specific risk factors Total
2 4 6
a In a single-account analysis (as is the case in the follow-up assessment), the word “pervasive” may seem out of place. However, these are factors that would impact multiple account balances if multiple accounts were present. We maintain usage of the “pervasive” modifier for comparative purposes with the data presented in Panels A and B. The underline values means that the numbers are being added together with the third number in the column being the sum.
average. Furthermore, students successfully identified approximately 11 of the 31 (35.5 percent) accountspecific risk factors. While these results may appear low, the case is very challenging, given that it contains a total of 35 IR factors, some of which are much more difficult to identify than are others. Furthermore, some students do not obtain all of the case information during their evidence searches, which precludes them from identifying some of the risk factors.14 Panel B of Table 4 presents the results of the follow-up assessment, which was administered to the same 23 students who completed the case. The assessment contained two pervasive IR factors and four account-specific IR factors. On average, students identified 1.18 (59.1 percent) of the pervasive risk factors and 3.09 (77.3 percent) of the account-specific factors. This is considerable improvement compared to the NSI case and is likely due in part to the experience students gained completing the NSI case as well as the subsequent in-class discussion, which highlighted aspects of IR assessment that students had previously missed. In general, feedback received from students who have completed the NSI case has been positive. Table 5 reports the results of a survey given to the 23 students who most recently completed the case. We used a 5-point scale ranging from 1 (Strongly Agree) to 5 (Strongly Disagree) (i.e., lower numbers represent greater agreement). Regarding our learning objectives, students indicated that the case increased their understanding of IR (mean of 1.78), how quantitative and qualitative information can be used to assess IR (means of 1.78 and 1.83, respectively) and how IR differs from CR (mean = 1.83). Students also indicated that the case required them to use their analytical skills to evaluate quantitative and qualitative information (mean of 1.35). Finally, students believed that the case increased their professional communication skills (means of 2.04 and 1.83 regarding communicating for requesting information from the client and communicating through constructing memos, respectively). Given that students found the case to be challenging (mean of 1.74), it is not surprising that they were somewhat neutral regarding their level of enjoyment (mean of 2.91), as performing new and difficult tasks, while valuable, can be frustrating for students. The student feedback reported here and the results from the follow-up assessment (reported in Panel B of Table 4) provide evidence that the case’s learning objectives are being met and students’ overall understanding of IR is improved following the completion of the case.
14 While we only report data on the follow-up exercise for the most recent implementation (with 23 students), all of the 123 students included in the case data also completed an additional information acquisition task (related to auditing cash) following the NSI case. We find that, on average, the students’ acquisition of information improved by 10 percentage points on the follow-up cash case. We interpret these data as evidence that students’ information acquisition skills improved as a result of the NSI case.
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Table 5 Post-case survey results (n = 23 students).a Survey question
Mean
Median
Std. dev.
The case increased my understanding of how quantitative factors (i.e., analytical procedures) should be used to assess inherent risk. The case increased my understanding of how qualitative factors (i.e., company and industry risks, complexity and subjectivity of accounts, fraud risk) should be used to assess inherent risk. The case increased my overall understanding of inherent risk. The case increased my understanding of the difference between inherent risk and control risk. The case increased my ability to request information from a client that is needed to complete an audit task in a professional manner. The case increased my ability to construct a memo that documents my analysis in a persuasive, professional manner. The case required me to analyze both financial and non-financial information to assess inherent risk. I found the case assignment to be challenging. I found the case assignment to be interesting and enjoyable.
1.78
2.00
0.67
1.83
2.00
0.78
1.78 1.83 2.04
2.00 2.00 2.00
0.95 0.83 1.19
1.83
2.00
0.78
1.35
1.00
0.71
1.74 2.91
1.00 3.00
0.96 1.08
a When completing the survey, students were given the following instructions: “Please indicate the extent of your agreement with each question regarding the Newport Soup, Inc. case, our subsequent discussion of it and the XYZ follow-up exercise by circling a number from 1 (Strongly Agree) to 5 (Strongly Disagree).”
6. Solution Case solutions are available, on request, from the corresponding author. Acknowledgments This paper has benefitted from the comments of Audrey Gramling, Tim Miller, Bob Ramsay, YiJing Wu, two anonymous reviewers, the Associate Editor and Editor of Journal of Accounting Education, attendees at the South Carolina Association of Educators meeting, and various undergraduate and graduate auditing students at the College of Charleston, University of South Carolina, and the University of South Carolina Upstate. Appendix A Guidance for communication with clients When making inquiries of your clients, the quality of the information you receive will often be a function of the quality of your inquiries. For this case, all of your communication will be via email. As such, these guidelines are specifically prepared to support high-quality email inquiries.
•
•
Edit your emails to eliminate grammar and spelling errors. While no client expects emails from auditors to be perfect, simple mistakes like using “there” instead of “their” can significantly impair a client’s perception of you. Most email software includes spelling and grammar check, but you should also proactively review your emails for errors that the software might not catch (i.e., the aforementioned “there” versus “their” error). When your inquiries are grammatically incorrect, your client may be unable to decipher your request and/or may be less inclined to respond in a complete manner. Use a professional and respectful tone in your emails. Inquiry with audit clients requires sensitivity, especially in an IR assessment task, because the auditor is trying to assess the likelihood that a material misstatement has been made by the client. The use of deferential terms like “please” and “thank you” is obvious, but you should also take special care to use language that is nonthreatening. Accusatory language of any kind is strictly forbidden. If your tone is perceived as being anything less than respectful, your clients will be less likely to respond favorably to your inquiries.
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•
•
Ask direct, well-informed questions. If you are trying to elicit a detailed response to your question, you should ask it in a manner that is direct and clear; ambiguity tends to be met with poor responsiveness. For instance, if you merely ask for “information” or “reports” your client will have no idea what you want. However, if you ask for a report by name (i.e., Monthly Sales Report) then your client will know exactly what you want. Additionally, you should ask questions that indicate that you have done an appropriate amount of analysis prior to asking the client. For example, if you are asking about a trend in your client’s revenues, then you should include your calculations of sales growth within your email inquiry. Clients will have little patience for questions to which you should already have the answers. Communications must be respectful of your client’s time. Clients have responsibilities other than answering your questions. The best way to deal with busy clients is to combine your questions into as few emails as possible. Combining your questions into one or two messages reduces the number of disruptions for the client. You should also ask the client your well-informed questions as early as you possibly can. This gives the client time to respond to your request at their convenience. If you need information by Friday, then you should try to request it on Monday or Tuesday. Requests at 5:00pm on Thursday for information you need from a client on Friday morning will likely be met with contempt. By asking for something at the last minute, you imply that your time is more important than your client’s time. On this assignment, if you do not have everything you need by the communicated deadline, then you will not receive it. Your client does not work weekends.
Appendix B Risk assessment template Instructions: Using the following template, describe the risk factors you considered while assessing the level of inherent risk for the account you indicate below. Next to each risk factor, insert a “+” or “−” to indicate whether the item increases or decreases inherent risk. Finally, indicate your overall assessment regarding the level of inherent risk for the account. Name of the account being evaluated: __________________________________ Risk factor description
Inc/dec inherent risk
1. 2. 3. 4. 5. 6. 7. 8.
Overall, the inherent risk for this account is assessed at: _______________________________ Appendix C Post-case assessment instrument (XYZ case) XYZ manufactures and sells electronic equipment. XYZ’s current CEO has an excellent reputation for honest financial reporting, but the company did have to restate its financial statements last year due to a material amount of inappropriate revenue recognition. You are the auditor for XYZ, Inc. You have been assigned to assess the inherent risk (IR) of XYZ’s Inventory Obsolescence Reserve for the current year. The accounting for this reserve is relatively simple to understand. Consider the Inventory Obsolescence Reserve to be similar to the Allowance for Doubtful Accounts. The Allowance for Doubtful Accounts is a contra asset to Accounts Receivable, whereas the Inventory Obsolescence Reserve is a Please cite this article in press as: Michael Cipriano, Erin L. Hamilton, Scott D. Vandervelde, Newport Soup Inc.: An interactive inherent risk assessment case, J. of Acc. Ed. (2016), doi: 10.1016/j.jaccedu.2016.07.002
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contra asset to Inventory. GAAP requires XYZ to have this account to recognize that at least some percentage of its Inventory is obsolete (no longer of value) when it gets to be “too old”. Last year, XYZ turned its inventory every 20.5 days and set an Inventory Obsolescence Reserve equal to 2.0% of Ending Inventory. Current year inventory turnover ratio calculation (based on current year un-audited numbers): Inventory turnover ratio Days to turn inventory
9 40.5 days
Inventory obsolescence reserve calculation (based on current year un-audited numbers): Ending inventory % of inventory Inventory obsolescence reserve
$15,000 ×1.0% =$150
Write a brief memo in which you assess the IR of the $150 Inventory Obsolescence Reserve for the current year based on ALL of the IR factors that an auditor should consider in IR Assessment. Appendix D: Supplementary material Supplementary data to this article can be found online at doi:10.1016/j.jaccedu.2016.07.002. References American Institute of Certified Public Accountants (AICPA) (2015). Code of professional conduct. New York. Arens, A. A., Elder, R. J., & Beasley, M. S. (2012). Auditing and assurance services (14th ed.). Upper Saddle River, NJ: Pearson Prentice Hall. Cunningham, B. M. (1999). Energizing your teaching: a view from deep in the trenches. Issues in Accounting Education, 14, 307–321. Janvrin, D. J. (2003). St. Patrick Company: using role play to examine internal control and fraud detection concepts. Journal of Information Systems, 17(2), 17–39. Kiger, J. E., & Rose, K. M. (2004). Internal control evaluation of a restaurant: a teaching case. Issues in Accounting Education, 19(2), 229–237. Knechel, W. R. (2000). Behavioral research in auditing and its impact on audit education. Issues in Accounting Education, 15(4), 695–712. Louwers, T. J., Ramsay, R. J., Sinason, D. H., Strawser, J. R., & Thibodeau, J. C. (2013). Auditing and assurance services (5th ed.). New York: McGraw-Hill Irwin. Messier, W. F., Glover, S. M., & Prawitt, D. F. (2016). Auditing & assurance services: A systematic approach (10th ed.). New York: McGraw-Hill Education. Public Company Accounting Oversight Board (PCAOB) (2010a). Identifying and assessing risks of material misstatement. Washington, DC. Auditing Standard (AS) 2110. Public Company Accounting Oversight Board (PCAOB) (2010b). Audit risk. Washington, DC. Auditing Standard (AS) 1101. Public Company Accounting Oversight Board (PCAOB) (2015). Auditing accounting estimates. Washington, DC. Auditing Standard (AS) 2501. Quiron, J. J., & O’Bryan, D. W. (2014). The mobile home monster: a forensic case in the use of public records to locate assets. Issues in Accounting Education, 29(2), 371–378. Ravenscroft, S. P., Buckless, F. A., & Hassall, T. (1999). Cooperative learning – a literature guide. Accounting Education, 8(2), 163–176. Rittenberg, L. E., Johnstone, K. J., & Gramling, A. A. (2012). Auditing: A business risk approach (8th ed.). Mason, OH: South-Western, Cengage Learning.
Please cite this article in press as: Michael Cipriano, Erin L. Hamilton, Scott D. Vandervelde, Newport Soup Inc.: An interactive inherent risk assessment case, J. of Acc. Ed. (2016), doi: 10.1016/j.jaccedu.2016.07.002