The SEC charged Major Corporation with overstating revenue in the amount of $458,000. The overstatement occurred because the company recorded sales for products that had been shipped but, at the time of shipment, the company had no reasonable expectation that they would be paid for the products. In the end, the company accepted most of the shipped product as sales returns.

Apparently, Major’s distribution agreements allowed the distributor the opportunity to return product to Major for credit whenever the distributor believed the product was unable to be sold. In FY 1994, the accounting personnel submitted a proposed allowance for future returns that was too low given the returns Major received in early 1995. Furthermore, management knew the exact amount of returns affecting FY 1994 prior to the time when the independent auditors finished their 1994 audit. If Major had accurately revised the allowance for sales returns, the amount of net revenue reported for FY 1994 would have been significantly reduced. Instead, management devised schemes to conceal the true amount of the returns, including preventing the auditors from examining the location where the returned goods were stored. Additionally, accounting personnel altered computer records to support a reduced level of returns.

Imagine that you are the independent auditor of Major. The audit plan outlines specific testing procedures to assess the fair representation of the “Sales Returns and Allowances” and “Accounts Receivable” accounts. In terms of strategic reasoning and the details provided in the case, what would be your actions in the following situations?

You only employ zero-order reasoning.

You employ first-order reasoning.

You employ higher-order reasoning.