J. of Acc. Ed. 26 (2008) 166–178

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Case

Waste Is Our Business, Inc.: The importance of non-financialinformation in the audit planning process

Jeffrey Cohen a,*, Ganesh Krishnamoorthy b,1, Arnie Wright b,2

a Boston College, Carroll School of Management, Chestnut Hill, MA 02167, United Statesb Northeastern University, College of Business Administration Boston, MA 02155, United States

a r t i c l e i n f o a b s t r a c t

Keywords:Risk assessmentAudit planning

Non-financial information

0748-5751/$ - see front matter � 2008 Elsevier Ltdoi:10.1016/j.jaccedu.2008.08.004

* Corresponding author. Tel.: +1 617 552 3165.E-mail addresses: cohen@bc.edu (J. Cohen), g.kri

1 Tel.: +1 617 373 4651.2 Tel.: +1 617 373 7351.

The objectives of this case are: (a) to alert students to the impor-tance of non-financial information in the audit process; (b) todevelop students’ ability to search for relevant financial andnon-financial information in the audit planning process; and (c)to emphasize the importance of resisting the natural tendencyto over-rely on financial information when conducting thefinancial statement audit. Students are asked to consider bothfinancial and non-financial information when evaluating aclient’s account balances. The client is in the waste businesswhere there are a number of market, regulatory, and politicalfactors that may affect the valuation of different accounts.Students are also directed to consider the importance of non-financial information in the integrated audit mandated by PCAOBStandard 5 and in fraud detection. The case can help studentslearn to explicitly consider non-financial information and under-stand the significance of integrating such information with finan-cial data. The case is suitable for use in undergraduate orgraduate auditing and assurance courses.

� 2008 Elsevier Ltd. All rights reserved.

d. All rights reserved.

shnamoorthy@neu.edu (G. Krishnamoorthy), a.wright@neu.edu (A. Wright).

J. Cohen et al. / J. of Acc. Ed. 26 (2008) 166–178 167

1. Introduction

The case presents a situation where the financial results of a company appear to present relativelylow audit risk, while non-financial information yields a different conclusion.3 The case was developedand tested in both undergraduate and graduate auditing classes.

The first objective of this case is to alert students to the importance of non-financial information inthe audit process. Critics have contended that many prior financial frauds could have been detectedhad auditors considered the consistency between reported financial performance and non-financialinformation, such as economic and industry trends (e.g., Erickson, Mayhew, & Felix, 2000). Conse-quently, auditing courses can benefit from including materials to help students develop the abilityto integrate financial and non-financial information. The case provides a means for students to explic-itly consider non-financial information and understand the significance of integrating such informa-tion with financial data when making audit planning judgments.

The second objective of the case is to develop students’ ability to search for relevant financial andnon-financial information in the audit planning process. Traditional auditing courses tend to empha-size learning audit standards and audit procedures, but relatively less emphasis is placed on develop-ing students’ ability to search for information that is relevant to the audit task at hand. With theexplosion of electronic information sources, effective and efficient information search is an importantskill for students to develop to be successful in the initial years of an auditing career American Insti-tute of Certified Public Accountants, 2005.

The third objective of the case is to emphasize the importance of resisting the natural tendencyto over-rely on financial information when conducting the financial statement audit. This objectiveis reinforced by asking students to consider both financial and nonfinancial information and theinterplay between these two types of information. The Committee of Sponsoring Organizations(COSO)., 2004 contains a reporting framework that includes both financial and non-financialinformation. The COSO document suggests that when evaluating risks of a client, auditors needto seriously evaluate a host of factors that include non-financial information. Further, Statementon Auditing Standard (SAS) 109 on risk assessment American Institute of Certified Public Accoun-tants., 2006 emphasizes the importance of understanding industry and contextual factors whenevaluating risks associated with a client. Specifically, SAS 109 suggests that auditors must considerthe unique characteristics of the client’s industry including its regulatory environment. Further,SAS 109 calls for an understanding of competitive conditions as well as supplier and customerrelationships.

2. Case materials

Eugene Debbs is a first-year senior auditor at Reed, Bradley and Frazier. It was a beautiful fall dayand Eugene planned to go camping over the weekend. However, Eugene had just started a newengagement, the audit of Waste Is Our Business and the weekend seemed like a distant dream. Thiswas an exciting assignment – his first as an in-charge audit senior – and the client was in an industrythat was new to him. In his preparation for the engagement, Eugene had discovered that while infor-mation on the non-financial aspects of the industry had been collected, it was not clear whether suchinformation had been utilized in prior audits to consider the risk of material misstatement(s). In accor-dance with examples provided in SAS 56 American Institute of Certified Public Accountants., 1988,non-financial information is defined as information that is not directly derived from financial state-ments, such as general economic conditions, technological changes in the client’s industry, and newproducts from competitors. Statement on Auditing Standard (SAS) 109 on risk assessment AmericanInstitute of Certified Public Accountants, 2006 also emphasizes the importance of understanding

3 An earlier version of the case was part of a research study using professional auditors (Cohen, Krishnamoorthy, & Wright 2000).The case is drawn from a public company in the trash disposal and recycling industry. The misstatement was reported in its revised10K filed with the SEC and related to a material write-down of inventory due to lower-of-cost-or-market. The company has sinceceased to operate as an independent entity and is no longer a listed company.

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industry and contextual factors when evaluating risks associated with a client. Specifically, SAS 109indicates that auditors must consider the unique characteristics of the client’s industry including itsregulatory environment. Further, SAS 109 calls for an understanding of competitive conditions as wellas supplier and customer relationships.

As Eugene considered the audit work papers from the prior year, he grew puzzled about how toconsider all of the non-financial information. He recalled his favorite accounting professor tellingthe class that ‘‘conducting an audit without integrating non-financial information is like playing crick-et without the wickets.” Eugene wasn’t sure what a wicket was, but thought this saying meant that ifyou focus too strongly on financial information, you risk missing a material misstatement in theclient’s financial statements.

Eugene asked his manager, Stephen Simnett, for advice, but Stephen just re-emphasized the needto consider financial and non-financial information since both sets of information are interdependent.As Eugene began to create the audit plan for Waste Is Our Business, the dilemma remained: howshould financial and non-financial information be integrated in the audit process? The following infor-mation on Waste Is Our Business was carried over from the prior year’s engagement.

2.1. Background

Waste Is Our Business, Inc. manufactures and sells a diversified line of waste handling equip-ment (loading containers, roll-off bodies, and transfer trailers) for the temporary storage and trans-portation of solid refuse. Sales of solid waste handling equipment account for approximately 94% ofthe total revenues of the Company. The remaining 6% of revenue is attributable to the steel pro-cessing business conducted by a subsidiary. The firm is of medium size within the trash equipmentindustry with operations mainly focused in the Eastern United States. The company’s relative posi-tion within the industry has remained largely unchanged over the last several years. Waste Is OurBusiness was incorporated in 1968 and shares of common stock were first issued to the public in1973.

Reed, Bradley and Frazier has audited Waste Is Our Business for the past five years and deliveredan unqualified (‘‘clean”) opinion each year. The company has an internal audit department staffed bycompetent employees and an effective audit committee comprised entirely of independent directors.The internal audit department reports directly to the audit committee without management beingpresent. The management of Waste Is Our Business has also played an active role in the designand implementation of the internal control system of the company. In compliance with SOX 404,Waste Is Our Business strengthened its control procedures and has given the internal audit depart-ment authority to monitor controls. Further, the financial reporting and budgeting systems of thecompany are monitored by management on an on-going basis to ensure a high degree of compliancewith the controls. The internal control reports issued by the auditing firm identified no materialunresolved control deficiencies.

Past experience relating to management representations indicates that management of Waste IsOur Business is generally credible and trustworthy. Each of the key executive officers has been con-tinuously employed by the Company for at least five years and is well respected by employees andbusiness associates. The board of directors, consisting largely of outside members (e.g., individualswith no business or legal relationship with the company), meets six times a year to monitor andprovide guidance to management on both operational and strategic issues. The audit committeeof the board meets with the external auditors on a quarterly basis and has always been supportiveof the need for auditors to be independent of management influence with respect to financialreporting.

The refuse container and compactor manufacturing industry is highly competitive. Several of theCompany’s competitors are substantially larger than Waste Is Our Business, with greater financial re-sources and a product range comparable to that offered by the Company. Furthermore, since substan-tial capital is not required, a number of small regional companies periodically enter the industry.Based on a customer survey, the Company’s management believes that its products are generallysuperior to those of most of its competitors because of the quality and amount of steel used. However,management also believes that consumers find the products from different suppliers interchangeable.

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Consequently, price and economy in operating costs are the principal means of competition within theindustry.

2.2. Industry trends

Sales in the transfer-trailer industry increased significantly during 2004 when legislation in theState of New Jersey was enacted to provide for a hastened scheduled closing of the State’s landfills,including the landfills that serviced the New York metropolitan area. Solid waste handlers were forcedto find alternative landfills in other states. The immediate reaction in the industry was to purchasetransfer-trailers to transport the solid waste from transfer stations to landfills or incinerators. As a re-sult, during the previous year the company experienced a sharp rise in the number of transfer-trailerssold. Since then, however, the waste equipment handling industry has experienced sluggish demandfor transfer-trailers among states along the Atlantic Seaboard due in part to the recent development ofalternative means (e.g., refrigeration trucks) of transporting solid waste and recycling. Hence, theupward demand for transfer-trailers observed in 2004 has not been sustained in 2005.

Industry analysts expect sluggish demand for transfer-trailers in the foreseeable future for severalreasons. The first reason is that the cost to transport solid waste to a landfill or incinerator is approx-imately $1.00 per ton-mile (i.e., the cost of transporting one ton of waste for one mile). Because trans-fer-trailers make the return trip empty, the relative cost to transport the solid waste is doubled to$2.00 for each ton-mile between the originating site and the landfill. A second reason that the demandfor transfer trailers is expected to be sluggish is that the solid waste handling companies have begunbailing the solid waste and transporting it to the landfills on flatbed trucks, refrigeration trucks, andother types of trucks which could transport cargo on the return trip from the landfill back to the orig-inating site, thereby lowering the cost of transport to about $1.00 per ton-mile. With the greater num-ber of trucks available to transport solid waste, competition has driven the cost per ton-mile evenlower and rendered it uneconomical for some solid waste handling companies to use their own trans-fer-trailers to transport solid waste. A final reason for the sluggish demand is that the solid waste han-dling companies have been selling their transfer-trailers thereby filling the marketplace with usedtransfer-trailers.

Recycling efforts may also have an effect on the industry. For example, in 2005 the New JerseyDepartment of Environment Protection indicated that the state plans to increase the recycling of mu-nicipal solid waste from the current rate of 32% to 50% over the next few years (<http://www.state.n-j.us/dep/dshw/recycle/plan05.htm>). As part of the continuing recycling efforts, solid waste handlershave intensified their efforts to separate paper, aluminum, glass and other reusable components of thesolid waste for recycling. This has resulted in up to a 10% decrease in the amount of solid waste beingtransferred to landfills or incinerators. Furthermore, because of increased costs of transportation todistant dump sites and other economic and political reasons, the State of New Jersey has slowedthe scheduled accelerated closing of the landfills, thereby reducing the immediate need to transportthe solid waste out of state. Several other states along the Atlantic Seaboard are experiencing situa-tions similar to that of New Jersey.

Finally, a leading trash bin manufacturer has begun retrofitting its existing containers with apatented trash-compaction device that reduces the volume of waste by 30%, thereby cutting trashtransportation needs proportionally. Several large customers of Waste Is Our Business have begunretro-fitting their existing bins with the new device and expect to have all their bins fitted withthe device in the next two years. This development is expected to negatively impact the demandfor transfer-trailers in future years. Further, a competitor is currently designing a transfer trailerwith a trash-compaction device built in, which could significantly increase the load capacity ofthe trailers. These transfer-trailers are expected to be available sometime next year. The cumula-tive effects of these factors are to reduce the quantity of trash that solid waste handling companieswill process for their customers, and thereby their revenues, while also lowering the demand forthe Company’s transfer trailers. The situation has caused management and the board to beconcerned about the financial health of its primary customers and to consider new strategies toenhance revenues. As a result, a new marketing program was embarked upon to expand intonew territories.

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2.3. Brief description of operations

2.3.1. Raw materialsSteel is the major raw material used by Waste Is Our Business. The Company has not experienced

difficulty in obtaining raw materials from domestic mills and warehouses, and management believesthat alternative sources of steel are readily available should difficulties arise. Steel is purchased incoils and priced by weight. The length of the coil may vary depending on the thickness of the steel.The Company has discovered that the thickness of steel purchased during the year was, on average,greater than that specified by company standards, due to a major vendor’s wider thickness toler-ances. This excessive thickness in steel resulted in fewer parts being stamped out of a coil of steelor, in other words, the process now required more pounds of steel per unit of product. As a conse-quence, the raw material cost per unit of product has increased significantly compared to standardallowances.

2.3.2. Manufacturing and distributionThe Company receives steel at their manufacturing locations where they cut, bend, shear, and form

the steel for assembly. Similar to other companies in the industry, the assembled products are thenpainted before delivery to the customer. Sales of the products manufactured by the Company aremade primarily to solid waste handling companies and distributors. During the year ended December31, 2005, the Company’s sales were approximately 82% to solid waste handling companies, 16% to dis-tributors, and 2% to government agencies. Past experience and data from credit rating firms indicatethat the credit risk associated with the customer base is very low.

2.4. Financial statements and other information provided by management

Selling and administrative expenses increased significantly between 2004 and 2005. This increasewas primarily due to additional expenses resulting from the Company’s attempts to expand into newterritories. Management notes that expanded selling and promotion efforts were performed to bolstersales for the coming year. The decrease in income tax expense is primarily due to changes in tax lawsthat impact the waste industry. These explanations have been separately verified by another auditoron the engagement team through additional audit tests and consultation with a tax professional.

The Company believes that it has adequate working capital for the next 12 months. No seriousproblem relating to the company’s viability as a going-concern is anticipated.

2.5. Requirements

Assume the role of Eugene Debbs as senior in-charge on the Waste Is Our Business engagement andaddress the following questions:

Question 1: During the planning process, auditors typically identify account(s) on which they planto place ‘‘additional testing” indicating further substantive testing is needed than would be normal forthat account. Additional substantive testing is performed when the auditor believes there is height-ened risk of a material misstatement after consideration of both financial and non-financial informa-tion. For example, this could be due to initial analytical procedures that suggest the account balancedoes not seem reasonable.

a. Use the financial statements in Appendix A to identify the account(s) for which the audit teamshould perform additional substantive testing by assigning up to a maximum of 100 points. Thegreater the additional testing over normal, the more points you should assign. Note thataccount(s) in which you would not perform additional substantive testing should be assigneda value of 0. Therefore, if you determine that there are no accounts that require additional test-ing, you would assign 100 to the ‘‘Unassigned Points” category. Please make sure that the sum ofpoints assigned to the account(s) plus the ‘‘Unassigned Points” category equals 100. Based onpast experience, assume that preliminary planning materiality has been set at $50,000 for allaccounts. For each account selected for additional testing, provide your reasons for deciding that

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the account needs additional testing, beginning with the account to which the highest pointswere assigned. There is no minimum or maximum number of reasons that you must provide.Be as specific as possible when explaining your answer.

b. For a maximum of three of the accounts you wish to provide additional testing, generate themost likely possible explanations for unexpected balances (e.g., explaining low revenues byasserting that ‘‘sales are down due to a decline in the economy”). There is no minimum or max-imum number of explanations that you must provide. Be as specific as possible when presentingyour answer. The most likely explanations for the unexpected balances can include both mis-statement (an error in the financial statements) and non-misstatement reasons (changes inbusiness conditions).

c. Based on your answers to parts ‘‘a” and ‘‘b,” discuss how you may potentially change the nature,extent, and timing of substantive audit testing.

Question 2: What are the most important pieces of non-financial information in the case? Do thefinancial statements present a picture of Waste Is Our Business that is consistent with the industryat the time period of the case? If not, how are the financial statements inconsistent with the industryinformation?

3. Teaching notes

The Waste Is Our Business case can be used in an auditing or an assurance services course at theundergraduate or the graduate level. The case is designed to be flexible, with each question indepen-dent of the others, so that instructors can use all or only some of the questions. If the complete case isused, it is recommended that a full session (75 minutes) be set aside for class discussion.

Case coverage begins with a discussion of analytical procedures in the planning phase, includingthe questions of whether examining financial information is sufficient when conducting analyticalprocedures and how auditors need to evaluate external business, political, and regulatory environ-ment factors. A SWOT analysis (strengths, weaknesses, opportunities and threats) for the clientcan be useful to highlight price pressures that potentially affect inventory valuation. Questions canbe adapted for searching for information in different years and to identify changes in auditing stan-dards. Answers for each case question are provided in this section, followed by a discussion of whyauditors need to look at both financial and nonfinancial information when evaluating accountbalances.4

Question 1(a) Identify accounts for which the audit team should perform additional testing. For accounts that

you identify as needing additional testing, please provide reasons for deciding that the account needsadditional testing, beginning with the account to which the highest points were assigned.

Students should recognize the importance of budgetary constraints in practice. The 100-point allo-cation balance illustrates the cost constraints imposed in audits and the importance of efficiency aswell as effectiveness. For instance, if inherent risk is considered to be normal for all of the accounts,audit scope need not be extended for any account with ‘‘unassigned points” equaling 100 (audit effi-ciency). The student is, thus, able to focus only on accounts considered to be of higher risk (auditeffectiveness).

Students may focus on financial trends when allocating points without sufficient consideration tonon-financial information. For instance, Tax Expense, Accounts Payable, and Accrued Liabilities havesignificantly decreased from the prior year, while Selling and Administrative Expense and the Allow-ance for Doubtful Accounts have increased. A simultaneous increase in selling and administrativeexpense and allowance for doubtful accounts may be a signal of weak market conditions that the

4 Cohen et al. (2000) showed that auditors primarily responsible for performing the planning phases of the engagement (initialanalytical procedures, risk assessment, and program planning) focused more heavily on financial data than non-financialinformation when establishing the scope of the audit. The auditors in that study typically used non-financial information asessentially corroborating the financial data.

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company may be trying to address by shoring up sales and marketing efforts as well as by bracing forhigher credit default rates from customers.

Students can seek industry and company-specific non-financial information to evaluate the ex-tent to which the financial trends are corroborated by non-financial information. For instance, ifindustry trends indicate that market conditions are not weak, additional accruals for selling andadministrative expenses and allowance for doubtful accounts could be an indication that the com-pany is engaging in earnings management; i.e., income smoothing by reducing its earnings. Alterna-tively, if industry trends indicate weakening market conditions, students should focus on whetherthe accruals for these expenses are adequate, given the risks faced by the company. Instructorscan also conduct ‘‘what if” analysis by demonstrating that when conducting percentage trend anal-ysis, the base amount in the initial year can wreak havoc with the analysis. Students may also focuson trends based strictly on year-to-year comparisons, without considering whether the expectationfor the current year may differ from realized values in prior years. A summary of financial trends for2005 and the related non-financial information that students should evaluate in developing expec-tations is provided in Table 1.

Instructors should emphasize the corroborating role of non-financial information to dispel the no-tion that stable financial trends imply that a client is on track. There are situations in practice wherethe financial representations appear consistent with the prior year, yet, based on industry and eco-nomic trends (non-financial information), these representations should have changed. For example,a stable sales pattern should be suspect when the client’s industry is suffering a decline, as is the casewith Waste Is Our Business. When using analytical procedures, auditors should focus on abnormalitiesand also investigate information that is ‘‘too consistent” (Pincus, 1994).

Student responses that take non-financial information under appropriate consideration (e.g., thedownward trend in demand) should include assigning extra testing to accounts involved in the rev-enue cycle (such as receivables and sales) and to inventory. The downward trend in the industrywith respect to the demand for the Company’s products along with product manufacturing problems(i.e., excessive steel thickness) raise questions about whether inventory should be written downunder the lower-of-cost-or-market rule. Furthermore, overall industry trends5 suggest that theCompany is likely to be significantly affected by trends in waste generation and recycling efforts.For example, the New Jersey Department of Environment Protection plan suggests an increase in therecycling of municipal solid waste from the current rate of 32% to 50% over the next few years (Stateof New Jersey, 2005). This plan could significantly decrease the amount of waste that is transported tolandfills, thus impacting the demand for transfer trailers that Waste Is Our Business sells in the NewJersey area.

(b) For up to three account selected for additional testing, generate possible explanations for unex-pected balances

Auditing standards (SAS 56) require the auditor to identify potential reasons for a material unex-pected fluctuation(s) (e.g., higher than expected sales) and investigate which reasons account for thefluctuation, whether due to business factors (e.g., higher product demand) or misstatements (e.g.,improper cutoff). This process of identifying potential reasons or causes for a material fluctuationis referred to as ‘‘hypothesis generation”. Students should understand the role of hypothesis gener-ation in the audit process for a number of reasons. First, the failure to initially identify underlyingissues leads to a failure to arrive at a correct solution (Libby, 1985). Second, an analysis of the typeof hypotheses generated (error versus non-error) can lead to the conclusion that most fluctuationsobserved in practice are non-errors (e.g., decline in gross margin due to competitive pressures).Although specific audit procedures to test for errors should be employed when necessary, students

5 Students can search for industry trends by performing a Google search with the key words ‘‘waste management trends” or‘‘trends in waste management”. For example, a search with the key words ‘‘waste management trends” provided insightfulinformation on the topic from several websites including the following: 1. Waste Management Trends in the WashingtonMetropolitan Region (<http://www.mwcog.org/uploads/pub-documents/Dl5f20030624150406.pdf>.); and 2. Waste Manage-ment—Trends for the Twenty-First Century (<http://science.jrank.org/pages/7296/Waste-Management-Trends-twenty-first-century.html>.).

Table 1Financial trends and non-financial information

Financial trend (2005) Non-financial information

Stable/Marginally increasing sales revenue Sluggish demand for transfer trailers by states along the Atlantic Seaboard;alternative means of transporting solid waste. Slowing of the scheduledclosing of landfills in New Jersey and other states, thus reducing long-hauls oftrash.

Relatively stable gross margin Problem with thickness of steel resulting in the use of more pounds of steelper unit of product, thus increasing the cost of the product relative to standardallowances

Increasing accounts receivable; higherallowance for doubtful accounts

82% of sales are to solid waste handling companies. These companies may beexperiencing lower demand due to competition from companies that havetrucks other than transfer-trailers (e.g., flatbed and refrigeration trucks).Increased recycling efforts and increased use of trash-compaction technologyresulting in lower amounts and volumes of trash being transported.Information regarding the financial health of the customer-base, i.e., solidwaste handling companies

Increasing selling and administrativeexpenses

Increased marketing efforts to expand into new territories

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should understand that an excessive focus on error explanations is unwarranted and can lead toinefficiency (over-testing).

The financial statements of the Company present a picture that is inconsistent with the availableindustry information. The demand for the company’s main product is declining on an industry-widebasis, yet the Company’s sales are flat (or slightly higher) with respect to last year’s sales. Whilethis does not necessarily imply that revenues are misstated, it should raise a cause for furtherinvestigation. Both error (e.g., revenue recognition issues) and non-error explanations (e.g., aggres-sive sales promotions) should be evaluated to explain the deviation from expectation of decliningsales.

The Company’s financial statements do not reflect the increased competitive environment and de-creased demand for transfer trailers. Key ratios relating to the inventory and revenue cycles: theinventory turnover ratio (ratio of cost of goods sold to average inventory) and the receivables turnoverratio (ratio of net sales to average receivables) are both relatively flat in the current year (see AppendixA), contrary to an expectation of a decline in both ratios. Both non-misstatement and misstatementexplanations for this deviation from expectations should be carefully evaluated using non-financialinformation, including explanations from management. For instance, a misstatement explanationmay be attempts by management to report a consistent earnings trend to appease shareholders andenhance their compensation.

Demographic and geographical differences across regions in which the company does businessmay account for the apparent inconsistency between non-financial information and the numbers re-ported in the financial statements. For example, the 2005 Annual Report of Waste Management Inc.indicates that significant volume-related increases in their waste collection and landfill businessesoccurred primarily due to the growth in business in the southern and western regions of the UnitedStates. Since Waste Is Our Business seems to have little exposure to the southern and western re-gions, the contrary indication in the non-financial information will need to be explored and inves-tigated more fully through means elaborated in the discussion to question 2 and through discussionswith management.

(c) Based on your answers to parts ‘‘a” and ‘‘b”, discuss how you may potentially change the nature,extent, and timing of audit testing.

This question highlights how potential misstatements may affect the nature, extent, and timingof testing. For example, the extent of testing may be modified by expanding cut-off tests to ensurea proper matching of sales with the completion of the earnings process. Further, there may be aneed to modify the nature of testing in the revenue cycle (accounts receivable, sales). For example,the nature of tests could be changed to include tests of the ‘‘existence” and ‘‘completeness” asser-tions by tracing back and forth between a sample of sales invoices and shipping documents. In

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addition, the testing could be modified in the inventory cycle by testing management’s assertionsabout the valuation and allocation of inventory to ensure that inventory is properly valued by thelower of cost or market principle. This could be achieved by performing a substantive analyticalprocedure such as comparing the current year’s standard costs with the prior year’s standard coststaking in to consideration the changes in external market forces. Further, the auditor could examinemanagement’s practices and controls over obsolete inventory and conduct further inquiry of man-agement concerning slow moving inventory. Finally, the timing of testing could be altered by doingmore year-end testing for accounts deemed to have unexpected fluctuations and where the auditorwill have more confidence in the results of tests performed closer to year-end or by more experi-enced auditors.

Question 2What are the most important pieces of non-financial information in the case? Do the financial

statements present a picture of Waste Is Our Business that is consistent with the industry in whichit exists? If not, how are the financial statements inconsistent with the industry information?

The most important pieces of non-financial information are those necessary to: (1) evaluate thetrends observed in the financial statements; (2) provide an independent basis from which to developexpectations for evaluating the financial information; and/or (3) provide an error or a non-error expla-nation for deviations from expectations.

Although the gross margin remains at about 21%, signs point to potential problems with inventory.The thickness of steel purchased is greater than that specified by company standards, suggesting thatdespite the lack of changes in gross margin, there is a potential inventory valuation issue regarding theproper treatment of cost variances since the cost per unit of product is apparently significantly greaterthan that allowed by company standards. With declining demand, there may also potentially be a low-er of cost or market problem. Hence, a greater audit focus on inventory appears warranted, despitestable inventory levels relative to the prior year balance.

Changes in demand for transfer-trailers suggest expectations of lower sales revenue for the cur-rent year and in the foreseeable future. The increased availability of used transfer-trailers at reducedprices is likely to create pricing pressure, which when combined with production costs in excess ofstandard allowances, should lead to an expectation of reduced gross margins. Reduced margins fre-quently signal an increase in the competitive landscape, prompting companies to offer liberal creditterms or to accept customers of lower credit quality, potentially resulting in a slow down in the col-lection of receivables and increased bad debts. Furthermore, the introduction by a competitor oftransfer trailers with a built-in compaction device could eventually lead to a reduced life-cyclefor the transfer-trailers manufactured by the Company with customers deciding to purchase thetechnologically superior competitor’s product. This situation raises issues, especially for future audityears, relating to obsolescence of the machinery used to manufacture the current model of transfer-trailers.

Students can explore a number of resources in the library and over the internet to obtain finan-cial and non-financial information. Sources of financial information include PriceWaterhouseCoopersEdgarScan (<http://edgarscan.pwcglobal.com/servlets/edgarscan>), Bloomberg, and Zacks InvestmentResearch (latter two available on a subscription basis only). These sources are useful for gaining aninitial understanding of the industry, the firms participating in the industry, and obtaining and ana-lyzing benchmarking data in order to compute financial trends (Questions 1 and 2). Additionalsources of information include S & P Industry Reports, ValueLine reports, and industry trade publi-cations (e.g., Environment and Waste Management). S&P Industry Reports and ValueLine reports areavailable in most university libraries and provide a valuable source of non-financial information,such as industry trends, overall industry growth rates, and political and legislative impact on theindustry.

With the explosion of information available on the internet, there are several sources of informa-tion available to students free of charge. For example, Yahoo Finance has financial and non-financialinformation for a number of key industries including the Waste Management industry (<http://biz.ya-hoo.com/ic/637.html>). Key industry information such as major industry participants, top performers,recent and upcoming industry events, and industry news are accessible through the website. In addi-tion, specific company analysis can be performed with the information provided on the website. For

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example, financial and non-financial information about Waste Management Inc., a key participant inthe industry can be obtained and downloaded from the Yahoo website (<http://finance.yahoo. com/q/pr?s=wmi>). The company specific information on the website includes a business summary, newsheadlines, company events, SEC filings, financial statements, major stockholder information, andinformation on executive compensation. The information from these reports is also useful in deter-mining the extent to which the non-financial trends are consistent with the financial information pre-sented in the case (Question 2).

Supplementary Question:Because the Sarbanes-Oxley Act of, 2002, especially Section 404 requirements on the evaluation of

controls, has dramatically affected the audit process, we have added an optional thought question thatan instructor may use to explore the role of non-financial information in the control environment.

Optional Thought Question: Is non-financial information relevant when performing the audit ofinternal control?

It appears from the official pronouncements that non-financial information is essential in conduct-ing the audit for internal control and for the financial statement audit. PCAOB Standards #2 and #5 de-scribe the requirements of an ‘‘integrated” audit, where knowledge of internal controls is used to driverisk assessments and substantive audit testing. The standard provides detailed guidance on planning aninternal control audit and reaching an opinion on management’s assessment of financial reporting con-trols. Paragraph 30 of Standard #2 states that the auditor should carefully evaluate the following non-financial information with respect to the company: (a) major issues affecting the industry in which thecompany operates including such matters as economic conditions and technological changes; (b) mat-ters affecting the company’s business such as operating characteristics, capital structure, and distribu-tion methods; and (c) legal or regulatory matters that are relevant to the company and its industry. Inorder for students to fully understand the most recent issues that affect the audit of internal controlsunder Section 404 and PCAOB Standards #2 and #5, students should be encouraged to visit the PCAOBwebsite at <www.pcaobus.org>.

Consideration of non-financial information during the evaluation of controls is important in allindustries. However, the role of non-financial information during a SOX 404 review potentially is evengreater in industries undergoing significant changes as opposed to industries that are relatively stable.For instance, industries affected by changing technology, increased global competition, or rapidexpansion or contraction in the market for their products or services experience pressures on theircontrol systems to a greater extent than companies in relatively stable industries.

4. Case assessment

One professor with two sections of undergraduate auditing and one professor with one graduatesection of an auditing class asked a total of 73 students to respond to the following questions usinga seven point Likert-type scale, anchored by (0) ‘‘No Effect and (6) ‘‘Great Effect”: To what extenthas your knowledge of the following issues been affected by working on the case: in considering finan-cial information in the audit planning process; in considering non financial information in the auditplanning process; information search in the audit planning process; in maintaining professional skep-ticism in the audit planning process; in integrating both financial and non financial information in theaudit planning process; the importance of analytical review in the audit planning process; the impor-tance of non-financial information in the SOX 404 related control evaluation process; and the impor-tance of non-financial information in the fraud detection process.

Overall, the median response to each of the above items was either a four (4) or a five (5), indicatingthat students perceive the case to be successful in achieving its learning objectives.

We also asked students four open-ended qualitative questions on the overall objectives of the case:

1. ‘‘What parts of the case do you think were most useful in furthering your understanding of theimportance of non-financial information in the audit planning process?” Common responsesincluded description of operations, information about steel prices, effects of the economic environ-ment, and pressure and changes within the industry.

176 J. Cohen et al. / J. of Acc. Ed. 26 (2008) 166–178

2. ‘‘What parts of the case do you think were most useful in helping you integrate financial and non-financial information?” Frequent responses included exploring client business strategies, the effectof the regulatory environment on valuation issues, and determining the context in which to con-duct analytical procedures.

3. ‘‘What parts of the case do you think were most useful in furthering your understanding of theimportance of information search in the audit planning process?” Common responses pertainedto searching for information about the industry, regulatory climate, the importance and role ofsteel in the industry, and the barriers to entry into the industry; and how the search might affectthe testing to be planned.

4. ‘‘What parts of the case do you think were most useful in furthering your understanding of theneed to maintain professional skepticism in the audit planning process?” Frequent responses per-tained to the inconsistency between the non-financial information and financial information, thetone of the company as well as its procedures and processes, the pressure management confrontsto ‘‘keep up the numbers” in an evolving industry, and how auditors must be willing to questionmanagement even when management has historically behaved honestly.6

Acknowledgements

We would like to acknowledge the helpful comments of Jim Rebele, two anonymous reviewers, LoriHolder-Webb and our students at Boston College and Northeastern University.

Appendix A

Waste Is Our Business, Inc.

Statement of earningsFor each of the three years ended December 31, 2005

6 Note that in our subfinancial information. Fuin Table 1 entitled, ‘‘Fina

2005(Unaudited)

sequent uses of therther, students havencial Trends and No

Percentagechange

case after we asbeen given additn-Financial Info

2004(Audited)

ked these initial queional guidance by bermation.”

Percentagechange

stions, studentsing provided wi

2003(Audited)

have been providedth the information sh

Pointsassigned

Net sales

$34,114,126 2.1% $33,408,355 9.2% $30,584,483 Cost of goods sold ($26,852,146) 2.6% ($26,180,415) 11.7% ($23,437,330) Gross profit $7,261,980 0.5% $7,227,940 1.1% $7,147,153 Selling and

administrativeexpenses

($5,139,200)

10.8% ($4,637,949) -0.3% ($4,651,424)

Operating profit

$2,122,780 �18.0% $2,589,991 3.8% $2,495,729 Other expenses (1316,386) �2.0% ($322,940) 153.2% ($127,524) Income before

income taxes

$1,806,394 �20.3% $2,267,051 �4.3% $2,368,205

Income taxexpense

(1318,100)

�59.6% ($788,200) �24.0% ($1,037,200)

Net income (loss)

$1,488,294 0.6% $1,478,851 11.1% $1,331,005 Total points carried forward Selected ratios and financial measures: Note: You have up to 100 points that you can assign to Income Statement and Balance Sheet accounts. The greater theadditional focus over normal, the more points you should assign. Note that account(s) in which you would not place additionalfocus should be assigned a value of 0. Therefore, if you determine that there are no accounts that require additional focus, youwould assign 100 to the ‘‘Unassigned Points” categoiy. Please make sure that the sum of points assigned to the accounts) and‘‘Unassigned Points” categoiy equals 100.

more non-own above

J. Cohen et al. / J. of Acc. Ed. 26 (2008) 166–178 177

Waste Is Our Business, Inc.

Industry (median)

2005

2004 2003 2005 2004 2003

Current ratio

2.36 2.15 2.21 2.41 2.27 2.42 Long term debt to

equit

0.47 0.52 0.51 0.51 0.50 0.48

Working capital

$9,039,368 $8,270,941 $8,156,741 $9,247,000 $8,727,591 $8,931,816 Return on assets 6.97% 7.10% 7.01% 6.90% 7.60% 6.87% Inventory turnover

ratio*

2.74

2.65 2.70 2.75 2.85 2.65

Number of days salesin inventory

133

138 135 133 128 138

receivables turnoverratio*,a

7.19

7.27 7.10 6.90 7.10 7.26

Number of days salesin receivables

50.79

50.19 51.41 52.90 51.41 50.28

Gross profitpercentage

21.29%

21.64% 23.37% 20.60% 22.80% 24.00%

Net profit marginratio

4.36%

4.43% 4.35% 4.10% 4.50% 5.10%

* Year-end balances of inventory and receivables was used in the computation of the inventory turnover and receivablesturnover ratios respectively.

a Net accounts receivable used in the computation of this ratio.

Waste Is Our Business. Inc.

Balance sheets as of December 31, 2005 and 2004

2005(Unaudited)

2004(Audited)

Percentagechange

Pointsassigned

Total points brought forwardcurrent assets

Cash and cash Equivalents $626,423 $576,369 8.7% Accounts receivable, less allowance for doubtful

accounts of 1 $153,673 |in 2005 and $93,874in 2004

4,747,095

4,593,651 3.3%

Inventory

9,303,225 9,667,363 �0.6% Prepaid expenses 524,387 417,986 25.5% Total current assets 15,706,130 15,455,394 1.6% Property, Plant, & Eouipment (Net) 4,806,842 4,523,772 6.3% Other assets 837,071 863,050 �3.0% Total assets $21,350,043 $20,842,216 2.4% current liabilities Notes payable 1,945,000 1,912,525 1.7% Current portion of long-term debt 499,830 408,317 22.3% Accounts payable 3,902,432 4,292,977 �9.1% Accrued liabilities and other liabilities 319,500 570,134 �44.0% Total current liabilities 6,666,762 7,134,453 �7.2% Long-term Debt, less current portion above 4,714,332 4,662,303 1.1% Total stockholders equity 9,963,949 3,995,455 10.3%

(continued on next page)

Appendix A (continued)

178 J. Cohen et al. / J. of Acc. Ed. 26 (2008) 166–178

Total liabilities and stockholders equity

$21,350,043 $20,842,216 2.4% Unassigned points Total points 100

Note: You have up to 100 points that you can assign to Income Statement and Balance Sheet accounts. The greater theadditional focus over normal, the more points you should assign. Note that accounts) in which you would not place additionalfocus should he assigned a value of 0. Therefore, if you determine that there are no accounts that require additional focus, youwould assign 100 to the ‘‘Unassigned Points” categoiy. Please make sure that the sum of points assigned to the Account(s) and‘‘Unassigned Points” categoiy equals 100.

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