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Waste Management: Top-Side Adjusting Journal Entries 1. Top-side journal entries are adjustments that are typically made by top management at the corporate level. According to the AICPA, these adjustments are typically made at the end of the financial reporting period and are not always posted to the general ledger. Often, these entries are not directly associated with actual economic activity as they do not emanate from the business operations of a division or a business unit .In evaluating the propriety of a top-side journal entry, an auditor would want to first interview management and review any set policies and procedures related to top-side journal entries. The auditors would also want to vouch the supporting documentation for economic substance and ensure that it has been properly entered in the financial statements. If, for instance, the top-side entries resulted in decreased depreciation due to increasing the salvage value of the trucks, the auditor may want to obtain written confirmation from an appraiser. 2. Top-side entries are usually made by upper managers at the very end of the reporting process. Paragraph 14 of Auditing Standard No. 5 states controls that might address these risks include -controls over journal entries and adjustments made in the periodend financial reporting process. So yes this paragraph does relate to the use of top-side entries at an audit client like Waste Management. 3. Quarterly period-end financial reporting does not always have to be evaluated by auditors as a significant and material process during an audit or internal control. However, year-end financial reporting process should always be evaluated by auditors as a significant and material process during an audit or internal control. A yearend financial reporting evaluation by an auditor is important to ensure that fraud, and/or a material misstatement has not occurred in the financial reporting process. 4. One specific control procedure that could be designed to prevent a misstatement related to a top-side adjusting entry from occurring would be to involve management from the operating units in the decisions to make all top-side adjusting entries related to their own operating units. For example, the company can implement a policy that both the top corporate executives and the management from the operating units must sign off on the entries. Another specific control procedure that could be designed to detect a misstatement that originated from a top-side adjusting entry would be to require that all significant top-side entries be reviewed by the audit committee. 1. Consult paragraphs 14-15 of PCAOB Auditing Standards No. 13. If you were auditing Waste Management, what type of documentary evidence would you require to evaluate the propriety of a top-side adjusting journal entry? Top-side journal entries are adjustments that are typically made by top management at the corporate level. According to the AICPA, these adjustments are typically made at the end of the financial reporting period and are not always posted to the general ledger.1 Often, these entries are not directly associated with actual economic activity as they do not emanate from the business operations of a division or a business unit. In evaluating the propriety of a top-side journal entry, an auditor would want to first interview management and review any set policies and procedures related to top-side journal entries. The auditors would also want to vouch the supporting documentation for economic substance and ensure that it has been properly entered in the financial statements. If, for instance, the top-side entries resulted in decreased depreciation due to increasing the salvage value of the trucks, the auditor may want to obtain written confirmation from an appraiser, or other evidence from a third party. Students may discuss various examples and types of evidence that would be required to evaluate the propriety of a \"top-side\" journal entry. Students' answers should support their examples as in the example above. The absolute key for the auditor is to evaluate the economic substance of the entry with sufficient and competent evidence. 2. Consult Paragraph 14 of PCAOB Auditing Standard No. 5. Based on the case information, do you think this paragraph relates to the use of top-side adjusting journal entries at an audit client like Waste Management in any way? Why or why not? Paragraph #14 of Auditing Standard #5 focused on the importance of auditors utilizing the results of their fraud risk assessments as part of the audit. Specifically, according to the paragraph, \"the auditor should evaluate whether the company's controls sufficiently address 1 AICPA. \"Journal Entries and Other Adjustments.\" The CPA Letter/Public Accounting Firms. June 2003. identified risks of material misstatement due to fraud and controls intended to address the risk of management override of other controls.\" Since top-side entries are a mechanism used by upper managers to circumvent the internal control system, paragraph #14 of Standard No. 5 clearly identifies the danger of unusual journal entries and entries made late in the reporting process explicitly, in the standard. At Waste Management, the management team was improperly overriding internal controls by making fraudulent top-side adjusting entries. The entries had no economic substance. Interestingly, the operating groups were not even aware of the adjusting entries that were being attributed to their operating groups. As such, they were being used as a way for internal control to be circumvented, essentially by management override. 3. Consult Paragraphs 26-27 of PCAOB Auditing Standard No. 5. Do you believe that the period-end financial reporting process should always be evaluated by auditors as a significant and material process during an audit of internal control? Why or why not? Paragraphs #26-27 of Standard No. 5 highlight the importance for auditors to understand and evaluate the period-end financial reporting process at a detailed level. Indeed, according to paragraph #26, \"because of its importance to financial reporting and to the auditor's opinions on internal control over financial reporting and the financial statements, the auditor must evaluate the period-end financial reporting process. The period-end financial reporting process includes the following: Procedures used to enter transaction totals into the general ledger; Procedures related to the selection and application of accounting policies; Procedures used to initiate, authorize, record, and process journal entries in the general ledger; Procedures used to record recurring and nonrecurring adjustments to the annual and quarterly financial statements; and Procedures for preparing annual and quarterly financial statements and related disclosures.\" Paragraph # 27 describes what the auditor should evaluate when obtaining an understanding and evaluating the period-end process. Specifically, \"As part of evaluating the period-end financial reporting process, the auditor should assess: Inputs, procedures performed, and outputs of the processes the company uses to produce its annual and quarterly financial statements; The extent of information technology ("IT") involvement in the period-end financial reporting process; Who participates from management; The locations involved in the period-end financial reporting process; The types of adjusting and consolidating entries; and The nature and extent of the oversight of the process by management, the board of directors, and the audit committee. The period-end financial reporting process should always be a significant process in the audit of internal control since many frauds can occur at this point of the process, especially if a company is falling short of the targets and/or projections set by the company and/or the analysts. It is also important to understand the period-end financial reporting process in detail to ensure that no one manager has too much power to override controls and make material adjustments to the financial statements. As a result, it should always be considered a significant process since the understanding and evaluation of the process has such a large impact on the financial reporting process. 4. Consult Paragraphs .71-71 of PCAOB Auditing Standrad No. 12. Identify one specific control procedure that could be designed to prevent or detect a misstatement related to a top-side adjusting journal entry. \"An entity may have implemented specific controls over journal entries and other adjustments. For example, an entity may use journal entries that are preformatted with account numbers and specific user approval criteria, and may have automated controls to generate an exception report for any entries that were unsuccessfully proposed for recording or entries that were recorded and processed outside of established parameters. The auditor should obtain an understanding of the design of such controls over journal entries and other adjustments and determine whether they are suitably designed and have been placed in operation.\" As a result, it is very important that the auditor take the time to explicitly link internal control activities to the risk of material misstatement posed by adjusting journal entries. Clearly, there are a number of allowable answers to this question. Importantly, this question is also designed to help the students understand the differences between preventive controls and detective controls and the importance of each in a well-functioning internal control system. And, it would be difficult to design control procedures that are likely to be effective against topside entries at Waste Management because of the weak control environment and the lack of ethics and integrity exhibited by top management. This point should be made because it illustrates the pervasiveness of the control environment. The bottom line is how effective are control procedures if management has the power to override internal controls? With that said, one specific control procedure that could be designed to prevent a misstatement related to a top-side adjusting entry from occurring would be to involve management from the operating units in the decisions to make all top-side adjusting entries related to their own operating units. For example, the company can implement a policy that both the top corporate executives and the management from the operating units must sign off on the entries. Another specific control procedure that could be designed to detect a misstatement that originated from a top-side adjusting entry would be to require that all significant top-side entries be reviewed by the audit committee