1
The proposed solution where some accounts slow their accrual rates while other (seemingly more important) accounts maintain their accrual rates is not acceptable purely as a means to achieve the firm's stated financial goals.
It would be acceptable to alter accrual rates if there was fundamental evidence that the accounts had been over accrued and that changes in the inherent business environment, the Company's business model or perhaps improved financial controls at the Company, supported such a change.
The change would likely be classified as a change in an accounting estimate and based on the magnitude described in the case, the change would likely require disclosure. If a change in estimate affects several future periods and materially affects the current-period, disclosure of the effect of the change on current income from continuing operations, net income and the corresponding earnings-per-share figures is required. 2
ZC (the client's accounting general manager) is well-meaning; however, his plan to change accrual rates without supporting evidence that there are changes in the business that support such a change is not ethical. Moreover, by circumventing the established chain of command in order to get the accrual rates changed, it is clear that ZC is not acting in an ethical manner. If he truly believes that the accrual rates have been too conservative, the matter should be brought to the attention of senior management who might then decide whether a change is warranted. In this way. the change is out in the open and not hidden.
DR (a key member of the audit team) initially appears to be ethical as he insists that the accrual rates not be changed without valid supporting evidence. However, DR's compromise solution, which appears to be made primarily to keep the peace with the long-term client (and perhaps to advance his own career), moves his behavior into an unethical realm.
The relationship between ZC and DR in and of itself is not inappropriate. The two have worked closely for a number of years and the relationship is common one in the scope of the auditor/client realm. The relationship becomes problematic when ZC seeks to Influence* the auditor directly and indirectly (by pushing the issue with senior management). The relationship also becomes problematic when DR agrees to a compromise solution.
3
The primary audit objectives for expense accruals, is to gather evidence to show both their existence and valuation. Auditors will want to see that the estimating methodology is applied consistently over different reporting periods and that the estimating methodology is supported by evidence (either actual experience or industry standards).
It is permissible for companies to overstate their year-end expense accruals with the goal of being conservative as long as the methodology is applied consistently over multiple periods and there is evidence to support the methodology. Year-end expense accruals should not be over-reserved to provide a cushion to 'manage* earnings results from period-to-period.
4
According the All section 722 from the Public Company Accounting Oversight Board.
The objective of a review of interim financial information is to provide the accountant with a basis for communicating whether he or she is aware of any material modifications that should be made to the interim financial information for it to conform with generally accepted accounting principles. The objective of a review of interim financial information differs significantly from that of an audit conducted in accordance with generally accepted auditing standards. A review of interim financial information does not provide a basis for expressing an opinion about whether the financial statements are presented fairly, in all material respects, in conformity with generally accepted accounting principles. A review consists principally of performing analytical procedures and making inquiries of persons responsible for financial and accounting matters/
A change in expense accrual estimating methodology as described in the case does have a material impact on reported financials and under Generally Accepted Accounting Principles (GAAP) the change should be disclosed along with supplemental information detailing the impact of the change and the reason for the change.