Case Study C Influenced by Incentives?

I was a senior working on a public company audit engagement. As part of our risk assessment, we evaluated the compensation and performance management process of a selection of key employees. I made selections of employees from many different sectors of the business and evaluated their compensation components, goals for the year, and recent performance evaluations. I was looking for any indicators that might lead to personal bias or a risk of material misstatement (including those resulting from fraud) that we had not previously identified. When I reviewed the documentation for the tax manager responsible for leading the tax accounting group (specifically focused on bookkeeping the companys tax transactions), as well as reviewing the companys tax provision and calculation of the effective tax rate, I noticed that one of her goals for the year was to reduce the effective tax rate by an overly aggressive percentage from the prior year. In addition, the companys compensation and bonus structure was tied to whether employees met their goals for the year.

Questions:

1. Identify the key red flags that heighten your professional skepticism, and explain why you believe them to be red flags.
2. Evaluate/Describe what you would do next.