Shoe Zoo Solution

ISSUES IN ACCOUNTING EDUCATION - TEACHING NOTES American Accounting AssociationVol. 27, No. 42012pp. 11–22

TEACHING NOTES

Shoe Zoo, Inc.: A Practice in Electronic WorkPapers, Tick Mark Preparation, and Client

Communication through the Audit ofProperty, Plant, and Equipment

Penelope L. Bagley and Nancy L. Harp

IMPLEMENTATION TOOLS

The Teaching Notes are accompanied by three additional files students will not receive: a

Word document titled ‘‘Prior Year Property Additions Listing’’ and two Excel files titled

‘‘Updated Property Lead Sheet’’ and ‘‘Solutions—Excel Work Papers.’’1 See Appendix A

for solutions to the Case Critical-Thinking Questions. See Appendix B for suggested solutions to

the Optional Background Reading Quiz/Assessment. For implementation ease, we have provided a

sample transcript of the questions students should ask the client’s controller, J. M. Perkins (played

by the instructor) and suggested answers to those questions (see Appendix C). In particular, the

students should ask the controller about the following issues related to Task 1, Substantive Detail

Testing of Gross PPE Additions:

� The student should ask why the 2011 building balance on the Property Lead Sheet (created

from a previously obtained trial balance) does not match the building balance on the Property

Roll Forward.

Penelope L. Bagley is an Assistant Professor at Appalachian State University, and Nancy L. Harp is anAssistant Professor at Clemson University.

We gratefully acknowledge Michael Bamber, Beau Barnes, Allen Blay, Brian Daugherty, Matt Hart, Marc Ortegren,Tracy Reed, Shane Stinson, and Ralph Viator for their valuable assistance and comments. We further thank BillPasewark, an anonymous associate editor, and two anonymous reviewers for helping to improve our case.

Supplemental materials can be accessed by clicking the links in Appendix D.

Please do not make the Teaching Notes available to students or post them on websites.

Published Online: November 2012

1 During a financial statement audit, auditors keep track of immaterial errors on a separate work paper. We did notinclude this as a requirement of the case, and therefore there is no such work paper in the accompanying solutions.Instructors can choose to add this requirement at their own discretion. See Appendix D for the links to thedownloadable supplemental materials.

11

� The student should request an updated trial balance (i.e., the Updated Property Lead Sheet

Excel file).� The student should ask about a repairs/maintenance expense improperly capitalized as

property, plant, and equipment.� The student should ask for you to arrange for him/her to physically observe the assets

selected for additions testing (Apple computers and office expansion).

Regarding Task 2, Substantive Analytical Procedures for Testing Depreciation Expense, the

student should explain to the controller his/her method for calculating an expectation for 2011

Depreciation Expense and then ask for potential explanations of why the actual recorded balance is

lower than the calculated expectation. The student should also ask for corroborative evidence that

can be examined to verify all explanations provided by the client.

The instructor can choose to be a helpful controller or a difficult controller to work with. In

addition, we recommend the instructor keep a tally of the number of times the ‘‘auditor’’ asks things

of the ‘‘client.’’ One point to reiterate to the students before completing the case is that the client’s

time is valuable and they should try to group questions together if possible.

The questions students will ask the senior will be much less formal than the questions they will

ask the client. Based on the implementation experiences, we anticipate that the students’ questions

for the senior will be primarily clarifying questions on how they should best complete their tasks

and document that they have done so. For example, students might notify the senior of balances that

did not properly agree and ask what they should do about them, students might ask the senior what

they should do about the physical asset that could not be observed, or students might simply want

reassurance that they are heading in the right direction with their documentation. The students will

also likely ask the senior about the misclassification error and its implications for internal controls,

in which case the senior should direct the students to examine the completed work papers

documenting controls testing and to find out more information regarding the error to determine

what impact the error has on using the control-reliance strategy for the financial statement audit.2

We recommend that the person playing the senior role become familiar with the case materials and

the suggested solutions so that he/she will be able to point the student in the right direction, without

simply giving away the suggested answers. Overall, the role of the senior is to help guide the

students when they have questions as they complete their audit program, much like a true audit

senior would.

Solutions

Students should turn in their completed work papers and their responses to the Case Critical-

Thinking Questions. The work papers should include all the tabs within the file called Excel Work

Papers. See Solutions—Excel Work Papers for the solutions to the above work papers. The

solutions are thorough; instructors should recognize that student responses will not likely be as in

depth and detailed. Also, the students may have more or less tick marks than the solutions.

Instructors can take this opportunity to provide feedback to the students regarding appropriate

information to include (and exclude) from the work papers.

We recommend the student be graded separately for his/her interaction with the client, his/her

work papers, and his/her solutions to the critical-thinking questions. Keeping in consideration the

lack of knowledge and experience the student has in communicating with clients, as well as

2 For simplicity, students are instructed in the case materials to document the impact of found errors on controls in atick mark on the work paper where the error is discovered. We recognize and encourage instructors to informstudents that the implications of an error on controls would be investigated and documented more thoroughly in atrue audit setting.

12 Bagley and Harp

Issues in Accounting Education - Teaching NotesVolume 27, No. 4, 2012

information provided previously during class lecture(s), we recommend the student be graded in the

following five categories for interactions with the client:

F: Overall, the student was unprofessional and rude in interactions with the client.

D: Overall, the student was cordial with the client, but there were a few instances when the

student was rude or unprofessional with the client.

C: Overall, the student was friendly with the client, however, there were several instances when

the student was abrupt and not clear with the client regarding information needed.

Examples include:

� Not properly greeting the client when asking for information, i.e., giving the impression

of barging into the client’s office.� Referring to documents using ‘‘auditor terms’’ that the client would not be familiar with,

such as ‘‘lead sheet.’’� When asking for additional information regarding additions, instead of referring to the

asset names, the student asks to physically observe ‘‘this asset.’’

B: Overall, the student was friendly with the client and had only a few instances when he/she

was not clear with the client. With few exceptions, the student properly greeted the client

when asking for additional information.

A: Overall, the student interacted very well with the client. The student was aware of the value

of the client’s time and tried to group questions together to limit the number of times he/

she needed to speak with the client. When he/she did speak with the client, the student

greeted the client appropriately and would ask if it was an ‘‘okay time’’ to talk.

We recommend the following five grading categories for the work papers, again keeping in

mind the student’s inexperience with work papers and tick marks, as well as information previously

provided in class lecture:

F: Overall, the work papers displayed a complete lack of effort by the student. Most of the audit

steps either were not performed and/or were not documented in the work papers.

Documentation in the work papers was incoherent, and instructions were not clearly

followed.

D: Overall, the evidence displaying that the audit program steps were performed is unclear or

incomplete. Several steps of the audit program were either not completed and/or not

documented in the work papers. The student failed to use complete sentences in

explanations, rendering it difficult to follow how the student addressed several of the steps

in the audit program.

C: Overall, the work papers displayed that most of the audit steps were performed. However,

there are several instances of unclear documentation, missing information, and/or errors.

Examples include:

� The student signed off on the particular audit program step, but the work papers do not

show any evidence that the step was performed. For example, in the Property Roll

Forward testing, the student signed off on Step 3 in the audit program, but there was no

documentation that the mathematical accuracy was tested in the Property Roll Forward

work paper (i.e., a tick mark or footing symbol was missing next to the balances that

were supposed to be footed or cross-footed).� There are instances of missing information, such as the student failing to complete the

asset addition information in the table on the Additions Testing work paper.� There are errors such as documenting that a numerical balance agrees to the lead sheet

when it does not. Other errors include incorrect work paper references, missing cross-

references, and failure to explain a difference when needed.

Shoe Zoo, Inc.: A Practice in Electronic Work Papers, Tick Mark Prep, Client Communication 13


B: Overall, the work papers are fairly clear, and each step of the audit program was performed.

Specifically, the audit program was properly completed, including the student’s sign-off

on each step and the appropriate reference to where that step was performed. There are

some errors as described in the ‘‘C’’ grade portion above, but primarily an outside reviewer

could follow within the work papers how each step was performed.

A: Overall, the student’s work papers provided clear evidence that each step of the audit

program was performed. Specifically, the audit program was properly completed,

including the student’s sign-off on each step and the appropriate reference to where that

step was performed. Additionally, the student usually made use of standardized tick marks

when appropriate (e.g., ‘‘f’’ was used to indicate that the balance properly footed, and

‘‘PY’’ was used to indicate the balance agreed to the prior year). Overall, unusual items

requiring additional explanation were clearly explained in complete sentences in a separate

tick mark (e.g., documenting that the asset addition that could not be physically verified

was verified through discussion with the Florida branch operations manager). There are

only a few of the errors described in the ‘‘C’’ grade description.

We recommend the instructors use their own discretion when grading the Case Critical-

Thinking Questions, keeping in mind the depth of the question-related topics discussed in the

textbook as well as in previous class lectures.

APPENDIX A

SOLUTIONS FOR CASE CRITICAL-THINKING QUESTIONS

This assignment is designed to help you make connections between the work you performed in

the audit of Shoe Zoo, Inc. and key concepts discussed in class. You should write a few sentences to

address each question below.

Task 1

1. Steps 3 and 4 of the Audit Program for Testing Gross PPE (WP #5600) required you to:

a. obtain a roll forward of activity in the PPE accounts from last year to the current year,

b. test the mathematical accuracy of the schedule, and

c. agree the beginning and ending balances per the roll forward to the amounts per the

lead sheet.

Why is a roll forward important in testing PPE for the year December 31, 2011? Why are

steps b and c above necessary? (Hint: how would your subsequent audit procedures be

affected if there were errors in b and c above, but you did not realize that because you did

not perform those steps?)

A roll forward is important to test the year-end balance of gross PPE because the auditor needs

to gain assurance about the December 31, 2011 amount on the balance sheet, but a great deal of

those dollars would have been subject to testing last year. It would be extremely inefficient for the

auditor to perform testing each year on the entire PPE ending balance. In PPE, a roll forward

provides an auditor with the activity (additions and disposals) that has occurred since the last

balance. Thus, the returning auditor can save time and simply test the PPE activity that occurred

since the last audit.

The auditor must ensure that the beginning balance per the roll forward agrees to the audited

balance from the prior year. If the beginning balance does not agree, then the auditor cannot be sure

that he/she will subject all the changes to PPE that occurred during 2011 to testing. The ending

balance must also agree to the lead sheet (i.e., the trial balance) because that is the balance that will

14 Bagley and Harp


ultimately be reported in the financial statements and/or footnotes. If the auditor does not ensure

that the roll forward is mathematically accurate, he/she may be testing PPE additions or disposals

information that is not complete or accurate.

In short, the roll forward allows a returning auditor to more efficiently test the PPE balance. He/

she can rely on the prior year audited beginning balance as a starting point, then simply subject the

changes to testing to form an opinion on whether the ending balance is free of material

misstatement. This approach is only effective if the beginning balance agrees to the prior year, the

ending balance agrees to the trial balance, and the schedule is mathematically accurate.

2. In class we have learned that audit evidence should be both ‘‘sufficient’’ and ‘‘appropriate.’’

Appropriate evidence must be both ‘‘relevant’’ and ‘‘reliable.’’ Discuss the reliability of the

evidence you collected in Steps 7 and 8. Which pieces were more or less reliable and why?

In Step 7, we vouched asset additions by obtaining invoices and checks. The invoices appeared

to be original documents that were created outside of Shoe Zoo, Inc. In general, inspecting

documents is considered to provide reliable evidence. Inspecting original documents is more

reliable than copies. Also, inspecting external documents (i.e., the invoices) is more reliable than

internally created documents (check copies). If the auditor were concerned about the reliability of

the check copies that are internally generated, he/she could also request that the client provide

cleared check copies from the bank or show where the check cleared the bank statement.

In Step 8, we attempted to physically inspect the asset additions. Audit evidence is considered

to be extremely reliable when the auditor physically inspects a tangible asset himself. This evidence

is even more reliable than inspecting documents (as in Step 7) because it involves the auditor

personally inspecting a real asset. In one case, we were able to physically inspect the asset

(computers), whereas in another case we had to rely on inquiry of a person in the Florida office who

was knowledgeable about the addition and was outside of the accounting department. The auditor

personally inspecting the asset provides more reliable evidence compared to discussing the

existence with a person within the company. An auditor can never fully rely on client inquiry for

evidence, but the combination of inquiring of the Florida person and the examination of invoices/

checks was deemed sufficient in this case. If there was a high risk in the PPE account or suspicion

of fraud, the auditor may have made a different decision (i.e., he/she would have physically

inspected the addition by personally visiting the Florida office).

3. Discuss the implications of the error found during property additions testing (i.e., the

computer repair that was incorrectly capitalized instead of immediately expensed). Write

your answer as if it were a recommendation to your senior about how to deal with the error

and how it impacts the audit. Consider in your discussion all of the following:

a. the dollar amount of the error,

b. the PPE acquisition process internal control implications of the error,

c. entity-wide internal control implications of the error,

d. how the audit plan may need to be revised (recall the Audit Risk Model), and

e. any additional risks signaled by the error and how to address them.

The error found in additions testing was extremely small (less than the $1,000 materiality

threshold). However, it is important to remember that we are sampling, and thus there is a risk that

errors beyond the ones we find in our sample selections exist. While individually immaterial, the

auditor would want to extrapolate the error to try to estimate the maximum impact of the error.

Additionally, in talking with the client about why and how the error occurred, we were able to

determine that a breakdown in internal controls led to the error. The property accountant was out on

sick leave for the entire month of April, during which time an accounting clerk took over her

responsibilities. Control PPE104, which appeared to be operating effectively in our control testing



working paper #4001, failed to operate effectively in April (which was not selected in our initial

control testing).

I recommend that we carefully evaluate the other responsibilities that the accounting clerk took

over during the month of April to see if there are other internal controls that failed in that month. I

also recommend that we make additional selections of PPE additions that were made in the month

of April, since it seems there are control problems in April when the property accountant was out.

We should also more carefully examine the repairs and maintenance expense account detail and

perhaps perform additional testing in the month of April.

We should also reconsider whether there are internal control problems at Shoe Zoo at more of

an ‘‘entity-wide’’ level. The client should have controls in place for properly training personnel,

overseeing personnel, and ensuring that qualified employees are available to backup people who are

on leave. We may want to inquire about other key employees who were out during the year and

how their responsibilities were covered.

In my opinion, the control failures in April mean that control risk is actually higher than we

initially assessed during our planning and control testing of working paper #4001. The audit risk

model tells us that Audit Risk¼ Inherent Risk 3 Control Risk 3 Detection Risk. Thus, to keep audit

risk constant in the face of higher than expected control risk, we must lower detection risk. This

means that we would want to make more selections in PPE testing. I recommend specifically

focusing those selections in April, the month in which controls were not operating effectively.

The error signals additional control risks in PPE and repairs and maintenance accounts. These

can be addressed as discussed above. The error also signals potential risks in other areas. If the

company does not have adequate personnel to step in when a key employee is out, there could be

other areas where errors exist when key client personnel were absent. I recommend we also inquire

of the client about compensating controls that exist at the company (e.g., budget-to-actual reviews,

reconciliation reviews) to minimize the likelihood that material errors will go undetected. We

should test those controls as well.

4. Assume the client corrects the error found during property additions testing (i.e., the

computer repair that was incorrectly capitalized instead of immediately expensed). Given

the correction, is no further testing necessary? Discuss the reasons supporting your answer.

The auditor should perform additional testing even if the client corrects the error detected in the

sample. Simply correcting the identified immaterial error is not sufficient because the underlying

problem may be pervasive. If the problem is pervasive and the auditor does not look into it, then

there could be material misstatements in the financial statements that go undetected. Therefore, the

auditor should gain an understanding of why the error occurred and perform additional testing as

needed.

In this case, the error occurred because of a failure in internal controls when an accounting

clerk took over the duties of the property accountant during the month of April. To determine what

additional testing is needed, the auditor should carefully evaluate the other responsibilities that the

accounting clerk took over during the month of April to see if there are other internal controls that

failed in that month. The auditor should also reconsider whether there are internal control problems

at Shoe Zoo at more of an ‘‘entity-wide’’ level. The client should have controls in place for properly

training personnel, overseeing personnel, and ensuring that qualified employees are available to

backup people who are on leave. The auditor should inquire about other key employees who were

out during the year and how their responsibilities were covered, to determine if additional testing is

needed in other areas. Additionally, the auditor should inquire of the client about compensating

controls that exist at the company (e.g., budget-to-actual reviews, reconciliation reviews) to

minimize the likelihood that material errors will go undetected. Those compensating controls

should also be tested.

16 Bagley and Harp


5. Examine the control testing of PPE101 and PPE102 provided with your case materials and

your own testing of PPE additions. Can you think of any ways the efficiency of the audit

can be increased for next year?

Next year the auditor could perform ‘‘dual-purpose testing.’’ Instead of making selections for

control testing and then different selections for additions testing, the auditor should use the same

selections made for substantive PPE additions testing to test whether controls PPE101 and PPE102

are operating effectively.

TASK 2

1. Why do you think the audit team decided to perform analytical procedures to test

depreciation expense? What factors were (and/or should be) considered to determine

whether an analytical approach (versus substantive tests of details approach) is appropriate

for testing depreciation expense at Shoe Zoo, Inc.?

Analytical procedures are particularly useful for income statement accounts, such as

depreciation expense where an auditor can determine an expectation in a fairly precise manner.

In this case, expected depreciation expense can be easily estimated based on audited balances (i.e.,

using the ratio of the audited depreciation expense from the prior year to the audited gross PPE

balance from the prior year).

In deciding to perform analytical procedures, the auditor also should consider the depreciation

process (i.e., whether it is a manual process or an automated process within the company’s fixed asset

system). Manual processes are more likely to contain human error, whereas automated processes may

be more stable and reliable. The auditor should also consider whether changes to the depreciation

policies occurred since the last year (i.e., changes in depreciable lives). Finally, the auditor should

consider whether it is more efficient to perform tests of details or an analytical procedure. In this case, I

think the auditor decided to use an analytical approach since there were no major changes within PPE

or depreciation policies and it is probably more efficient than making sample selections.

2. Do you think the error (resulting from a failure of controls while the fixed asset accountant

was on leave) you found in your PPE additions testing has any implications for the

depreciation expense testing? Discuss.

It is possible that the accounting clerk who replaced the fixed asset accountant also made errors

when entering fixed asset information in the company’s fixed asset accounting system. For

example, if she incorrectly set up an asset account, then the system could be calculating too much or

too little depreciation expense. The PPE Additions Listing shows only three PPE additions in April,

so the effect of any error is probably small for 2011. However, it is also possible that the PPE

Additions Listing for April additions is incomplete if the accounting clerk did not properly

capitalize all April PPE additions. The auditor should discuss these potential implications with the

audit team and the client to determine the next audit steps.

3. In testing depreciation expense, you performed client inquiries to determine why the

expected balance was not closer to the balance recorded by Shoe Zoo, Inc. Why is inquiry

alone not enough for a high-quality audit? What else did you do (or what should you have

done) instead of relying only on the client’s explanation?

Client inquiry alone does not provide persuasive audit evidence. This is because it is very easy

for client personnel to say things that are either accidentally inaccurate or purposely false if they do

not have to back up their statements with additional documentation. An important part of being an

auditor is to maintain an attitude of professional skepticism. Thus, an auditor should be skeptical of

client explanations until they are corroborated with additional evidence.

In the case of testing depreciation expense, instead of simply relying on the client’s claim that

there were large ‘‘end-of-year’’ additions skewing our expectation, we ensured that was true by



examining the PBC Additions Listing (which was subject to testing in our PPE additions working

papers). We also ensured that what the client told us about the depreciation policy matched the

actual depreciation policy documentation we were provided. We also did not rely on the client’s

claim that no large ‘‘end-of-year’’ additions happened last year. Instead we obtained the prior year

additions listing from our prior year working papers and ensured that there were no such additions

occurring after December 15 in the prior year.

APPENDIX B

OPTIONAL BACKGROUND READING QUIZ/ASSIGNMENT SOLUTIONS

1. What is the name of your audit firm?

Answer: Kerzman and Lee, LLP

2. Task 1 of the case is primarily about auditing which account?

Answer: Property, Plant, and Equipment

3. Task 2 of the case is primarily about auditing which account?

Answer: Depreciation Expense

4. What documents have been provided by the client in the PBC documents?

Answer: 2011 Property Additions Listing

Invoice from Computer Supplies, Inc.

Invoice from Florida Builders, Inc.

Invoice from Granny Smith Computer Repair

Check copy to Computer Supplies, Inc.

Check copy to Florida Builders, Inc.

Check copy to Granny Smith Computer Repair

Fixed Asset Depreciation Policy

5. At what amount has materiality been set for Task 1?

Answer: $1,000

6. What is the predetermined threshold for tolerable difference in Task 2?

Answer: $1,000

7. In what work paper(s) would you find prior year and current year gross property balance?

Answer: Property Lead Sheet and Property Roll Forward

8. Task 2 involves performing what type of audit testing?

Answer: Substantive Analytical Procedures

APPENDIX C

SAMPLE TRANSCRIPT OF STUDENT QUESTIONS AND SUGGESTED RESPONSES

Note: Students’ questions will likely vary from those listed below. However, the basic content

should remain the same. In addition, below are suggested responses, which can also vary greatly.

18 Bagley and Harp


Student Questions (italicized) and Suggested Answers:

Task 1: Substantive Detail Testing of Gross PPE Additions

1. Why doesn’t the amount on the trial balance (i.e., the lead sheet) you gave us earlier matchthe amount on the roll forward sheet you gave us?

Oh, that trial balance I originally gave you was just a preliminary trial balance. There was

a journal entry for an addition that didn’t get booked until later. (Note: The term ‘‘lead

sheet’’ is common among auditors, but not to the client. If the student references ‘‘lead

sheet’’ instead of ‘‘trial balance,’’ we recommend that as the client, you act is if you are not

familiar with such terminology.)

Potential follow up question the student should ask: Can you provide me with a few moredetails about this addition?

Sure. The Florida branch manager neglected to notify and turn in the paperwork for an

addition to the corporate branch until after the company books were closed for December

31, 2011, and the preliminary trial balance was created. The property accountant detected

the error and properly entered the addition into the general ledger as of December 31,

2011. So, the entry was made to increase the building account of $78,097 for the Florida

branch addition that occurred late in the year 2011. It is properly included in the roll

forward and is also reflected in the new trial balance.

Potential follow up question the student should ask: Can I have the updated trial balance?

Sure, here it is. (Provide student with the file, Updated Property Lead Sheet. Inform the

student that he/she can assume this is the lead sheet created from the updated trial balance.)

(Note to instructors regarding Question 1: We recommend you tell the students to replace the

original lead sheet with the updated lead sheet in the working papers. The student should

number the updated lead sheet the same as the original lead sheet [5610], and should foot and

agree the updated lead sheet to the roll forward and the prior year balances. At the instructor’s

discretion, the students may also be required to turn in the original lead sheet with tick marks

discussing the differences they noted. The original lead sheet with the incorrect balances serves

as an opportunity for the students to practice documenting a discrepancy and how it was

resolved.)

2. Could you help me understand why there appears to be a computer repair capitalized withthe purchase of Apple Computers for the Marketing Department? (Shows the client the

addition selected from the additions listing, and the two invoices and checks.)

Hmmm. Let me take a closer look at those invoices. Yes, I see what you are talking about.

It does look like $972 of the total amount should not have been capitalized. I do remember

Sarah from Marketing spilling a soda on her Apple laptop. That must have been when

Sarah’s computer got fixed. I’m not sure how that did not get recorded as a repair, but

don’t worry about it. I’m sure an amount that small is well below your materiality, right?

Please don’t tell me we need to make a big deal out of such a small error.

Potential student follow-up question: I would just like to understand a bit more about how theerror occurred. Even though this particular error is very small, I need to understand ifthere is some kind of systematic problem in your internal controls around capitalizingassets versus recording repairs and maintenance expense.



Other members of the audit team already tested our controls. They did not find any

problems in our controls around capitalizing assets. I think this was just an isolated slip-up

in a tiny amount. Are you sure your senior wants you to keep digging into this and wasting

time? Please go talk to your senior, and meanwhile I’ll start looking into what might have

gone wrong in this one little error. If you still need to know more about this, come back in

a little while and I should know more by then.

(Note: The student should go to talk with the audit senior at this point. The senior will advise

the student to look at the controls working papers provided with the case materials to get more

familiar with what has already been done in that area. The senior will also advise the student to

continue investigating how this error took place because the team may need to do more testing

if controls are not reliable in this area. The student should go back to the client to find out more

details after looking through the controls materials included with the case materials.)

Student follow-up question: I looked at our control testing working papers around recordingfixed assets. Our team randomly selected February and September to test the monthlydetailed review of property additions. We saw sign-offs on the February and Septemberdetailed property additions report indicating that it was prepared by the propertyaccountant. We also saw sign-offs by the appropriate department heads whosedepartments had property added in those particular months. It looks like the controlswere working at least in February and September. Did you find out any more informationabout how this error occurred?

Yes. I should have thought of this earlier, but I think I know what happened. The invoices

and checks are dated in early April. Our property accountant, Mary Swanson, was on a

medical leave for the entire month of April. She had an emergency unplanned surgery. She

is very particular and would never have made this error if she was working. We had an

accounting clerk, who normally assists our treasury manager, take over the process for

inputting property into our fixed asset system. I was overseeing her work, but I guess I just

didn’t look closely enough to notice that a $972 repair invoice somehow got into the

property additions.

Potential student follow-up question: So was there a detailed review of property additionsperformed for April, while Mary Swanson was out? Could we see that document?

No, I was behind in my work since Mary was out and the accounting clerk who took some

of her responsibilities did not know she was supposed to prepare that report and coordinate

getting department heads to review the listing if their department got any new property. I

guess this just slipped through the cracks. The good news is that Mary was back in her

position by May, so only April should have potential errors. I doubt there are any other

problems though.

3. I would like to verify the physical existence of the Apple computers, could you arrange forthat to happen?

Sure. I arranged for you to go with our operations manager, John Smith, on February 15, at

2:15 p.m. to view the computers. You examined the asset and found it to match the

description given in the property listing, and to be in good condition and use.

(Note: Inform the student that he/she is to assume they did observe the asset under the above

conditions and should document that accordingly.)

4. I would like to observe the office expansion. Could you arrange that for me?

20 Bagley and Harp


Well, it’s out of state (i.e., in Florida) so I am not sure how you are going to do that.

Potential student follow-up question: Is it possible for me to verify with someone in the Floridaoffice that the addition exists?

Sure. You called Florida branch operations manager Melissa Watson, and she verified that

they recently expanded the office and the addition is valid. (Note: Inform the student that

he/she is to assume the above conversation did occur and should document that

accordingly.)

(Note to the instructors: The student may ask you, the client, about a $1 difference between the

property lead sheet and the roll forward in the computer balance. In addition, the student may

ask about the $215 difference between the additions listing and the additions amount on the roll

forward. Both amounts are immaterial and should not be of concern to the student. As the

client, feel free to become annoyed if asked about such ‘‘trivial’’ differences.)

Task 2: Substantive Analytical Procedures for Testing Depreciation Expense

Note to instructors: It is possible for students to complete the Analytical Procedures satisfactorily

without talking to the client. The students are given the depreciation policy and additions listing,

therefore with careful analysis some students may be able to identify on their own that the

Warehouse Expansion and Office Building addition should not be included in the calculation of

depreciation expense and adjust their calculations accordingly.

1. I am testing depreciation expense and am having a little trouble. We are testing the accountjust like last year, with substantive analytical procedures. I came up with an expectation fordepreciation expense, and when I compared it to the recorded balance, the recordedbalance was much less than expected. Could you help me figure out why the recordedbalance is lower than my expectation?

Sure, I can try to help. How did you calculate your expectation?

Potential student follow-up: Well, we used the relationship between last year’s depreciationexpense and the average gross PPE from last year to come up with our expecteddepreciation expense. We figured out that last year, depreciation expense represented 3.55percent of the average gross PPE balance from last year. Since we don’t think there wereany changes to your depreciation methodology, we figured that a reasonable expectationfor this year’s depreciation expense would be 3.55 percent of this year’s average grossPPE balance. Does this expectation make sense based on your knowledge of depreciation,any changes in depreciation methods, and changes to PPE this year?

Hmmm. Yes, I would expect that the relationship between last year’s depreciation expense

and gross average PPE would be the same as this year. However, now that I think about it,

we did make two pretty big acquisitions really late in the year. Let me check something.

(Here, the controller pulls out his copy of the 2011 Additions Listing.)

Yes, see these two additions to the building account? Notice that the Warehouse

Expansion for $107,653 was made on December 28, 2011, and the Office Building

Addition for $78,097 was made on December 30, 2011. I think that explains why your

expectation was higher than the recorded balance.

Potential student follow-up question: I’m still not sure I understand how this makes myexpectation too high. Can you clarify for me?



Well, our ‘‘Fixed Asset Depreciation Expense Policy’’ (which we gave you in the PBC

documents) clearly states that assets acquired after the 15th day of a given month shall

begin depreciation expense in the following month. These two big balances are included in

gross PPE at year-end, but since they were acquired on December 28, 2011, and December

30, 2011, they did not get any depreciation expense for 2011. I think you should remove

those two additions from your ‘‘ending balance’’ of gross PPE for purposes of calculating

an expectation for depreciation expense. I suggest that you re-run your calculations after

taking away those two big acquisitions on December 28, 2011, and December 30, 2011,

from the gross PPE balance at December 31, 2011. Last year, we didn’t have any big

acquisitions at the end of December, so I guess this problem didn’t happen last year.

Potential student follow-up: OK. That makes sense. Do you have a copy of last year’s additionslisting so that I may verify that there were not any large additions at the end of Decemberlast year for which I would need to adjust my 2011 expectation?

Well, your team audited property last year as well. Isn’t last year’s property additions

listing with your prior year working papers? I guess I can dig one up if you can’t find it.

Potential student follow-up: Sorry, you are right. I will ask my senior to help me find it in lastyear’s working papers. Thank you for your help. I will verify what you have told me withthe depreciation policy and last year’s addition listing. Then I will re-calculate myexpected depreciation expense, compare it to recorded depreciation expense, and let youknow if I have any other questions.

(Note to the instructors: We recommend that the student ask the senior for the prior year

additions listing [i.e., Prior Year Property Additions Listing]. Alternatively, the prior year

additions listing could be included with other files from the prior year (i.e., the prior year

audited financials and prior year depreciation expense lead sheet) that were provided to the

student at the beginning of the case.)

APPENDIX D

Prior Year Property Additions Listing: http://dx.doi.org/10.2308/iace-50251tn.s1

Updated Property Lead Sheet: http://dx.doi.org/10.2308/iace-50251tn.s2

Solutions—Excel Work Papers: http://dx.doi.org/10.2308/iace-50251tn.s3

22 Bagley and Harp


http://aaajournals.org/doi/suppl/10.5555/iace-50251TN/suppl_file/10.2308_iace-50251tn.s1.doc

http://aaajournals.org/doi/suppl/10.5555/iace-50251TN/suppl_file/10.2308_iace-50251tn.s2.xlsx

http://aaajournals.org/doi/suppl/10.5555/iace-50251TN/suppl_file/10.2308_iace-50251tn.s3.xlsx

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