Uploaded by Kate Mercado

Activity 3

Activity – Understanding the entity and its environment
The auditor needs to assess management integrity as a potential indicator of inherent risk,
particularly as it relates to the potential of fraud. Although the assessment of management
integrity takes place on every audit engagement, it is a difficult and subjective task. It requires
professional skepticism on the part of the auditor because it is human nature to trust people whom
we know and interact with.
For each of the following management scenarios, (1) indicate whether you believe the scenario
reflects negatively on management integrity, and explain why; and (2) indicate how the
assessment would affect the auditor’s planning of the audit
Management Scenarios:
1. The owner/manager of a privately held company owns three other companies. The entities
could be run as one entity but they engage extensively in related-party transactions to
minimize the overall tax burden for the owner/manager.
It will reflect negatively on management integrity because reducing tax burden means
avoiding genuine tax to be paid to the government.
This will affect the auditor’s planning of audit as cross-organizational transactions need to
be carefully analyzed and looked into, thus, creating confusion in the part of the auditors.
2. The president of a publicly held company has a reputation for being stubborn with a violent
temper. He fired a divisional manager on the spot when the manager did not achieve profit
It will not affect management’s integrity because the issue is performance-based.
It will not affect the auditor from preparing the audit.
3. The financial vice president of a publicly held company has worked her way to the top by
gaining a reputation as a great accounting manipulator. She has earned the reputation by
being very creative in finding ways to circumvent pronouncement to keep debt off the
balance sheet and in manipulating accounting to achieve short-term earnings. After each
short-term success, she has moved on to another company to utilize her skills.
Reflects negatively to management’s integrity as accounting manipulation is unethical,
thus, resulting to misstatements.
This will create many problems to the auditor for the data are misstated and he shall be
discovering these problems.
4. The president of a small publicly held firm was indicted on tax evasion charges seven
years ago. He settled with the BIR and served time doing community service. Since then,
he has been considered a pillar of the community, making significant contributions to local
charities. Inquiries of local bankers yield information that he is the partial or controlling
owner of several corporations that may serve as “shell” organizations whose sole purpose
is to assist the manager in moving income around to avoid taxes.
This will negatively affect the integrity of the management since the president, in the name
of charity, is involved in fraudulent activities
Many problems will arise in the auditor’s report because there are illegal transactions.
5. Jaime Juan is the president of a privately held company that has been accused of illegally
dumping waste and failing to meet government standards for worker safety. Jaime
responds that his attitude is to meet the minimum requirements of the law; if the
government deems that he has not, he will clean up. “Besides,” he asserts, “it is good
business; it is less costly to clean up only when I have to, even if small fines are involved,
than it is to take leadership positions and exceed government standards.”
It will reflect negatively on management’s integrity because the president is not following
rules and regulations set by the government.
Moreover, these transactions that violate rules and regulations will be a problem for the
auditor and will affect the audit report.