MERCADO, FACEL KATE R. BSA 3-A 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 goals. 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. MERCADO, FACEL KATE R. BSA 3-A 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.