A client is determining its accounting treatment for new types of long-term contracts. Consider the differences in outcome for the two scenarios below regarding the approach the client and auditor took. How does framing relate to the two different scenarios? Scenario A: The client entered into a large number of long-term sales contracts and recorded revenue using an approach they determined was
the preferred approach, with no consultation or discussion with the audit engagement team. The engagement team conducted revenue recognition testing to ensure that the client correctly followed the chosen approach. The engagement team noted that the client consistently and accurately applied the approach and determined that the audit testing supported the amount of revenue reported by the client. Scenario B: Before entering into long-term contracts with customers, the client reached out to the audit engagement team to discuss the client’s preferred approach for recognizing revenue. The team researched authoritative accounting standards and considered the client’s preferred alternative. The team also considered other possible approaches and consulted with other engagement teams with experience in accounting for long-term contracts. Based on this process, the engagement team determined that although the client’s preferred approach had merit, another alternative was more consistent with accounting principles for revenue recognition. The client carefully reconsidered the situation and ultimately decided to use the alternative suggested by the engagement team to recognize revenue associated with the long-term contracts they entered into.
What will be an ideal response?
In Scenario A, the auditor appears to have adopted the client’s frame without considering alternatives. While
the client’s accounting treatment may have been correct, the auditor did not apply sufficient professional
skepticism. In Scenario B, the auditor took time to understand the client’s frame and then also challenged
that frame by researching and considering alternative perspectives. Considering more than one frame is
the “stuff ” of professional skepticism. In Scenario B, rigorous application of professional skepticism led the
engagement team to recommend a different revenue recognition accounting treatment.
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