The auditor needs to assess management integrity as a potential indicator of inherent risk, particularly as it relates to the poten- tial for 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.

a. Define management integrity and discuss its importance to the auditor in determining the type of evidence to be gathered on an audit and in evaluating the evidence.

b. Identify the types of evidence the auditor would gather in asses- sing the integrity of management. What are sources of each type of evidence?

c. For each of the following management scenarios, (1) indicate whether you believe the scenario reflects negatively on manage- ment integrity, and explain why; and (2) indicate how the assess- ment would affect the auditor's planning of the audit.

Management Scenarios

i. The owner/manager of a privately held company also owns three other companies. The entities could be run as one entity, but they engage extensively in related-party transactions to min- imize the overall tax burden for the owner/ manager.

ii. 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.

iii. 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 FASB pronouncements 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.

iv. The president of a small publicly held firm was indicted on tax eva- sion charges seven years ago. He settled with the IRS 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.

v. James J. James 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. James 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."