Case Description:

In the audit of a municipal government, the auditors discovered that receivables for property taxes were overstated because the tax assessor stole some taxpayers’ payments.

J. R. Shelstad had been the tax assessor–collector for 15 years in the Ridge Municipal District, a large metropolitan area. Known as a “good personnel manager” Shelstad pocketed 100–150 counter payments each year, in amounts of $500–$2,500, stealing about $200,000 a year for a total of approximately $2.5 million. The district had assessed about $800–$900 million per year in property tax revenues, so the annual theft was less than 1%. Nevertheless, the taxpayers got mad.

In Shelstad’s assessor–collector office, staff processed tax notices on a computer system and generated 450,000 tax notices each October. An office copy was printed and used to check “paid” when payments were received. Payments were processed by computer and a master file of accounts receivable records (tax assessments, payments) was kept on the computer hard drive.

Shelstad was a good personnel manager, who often took over the front desk at lunchtime so the teller staff could enjoy lunch together. During these times, Shelstad took tax payments over the counter, gave the taxpayers a counter receipt, and pocketed some of the money, which was never entered in the computer system.

Shelstad eventually resigned when the district’s assessor–collector office was eliminated upon the creation of a new region-wide tax agency.

Audit Trail: The computer records showed balances due from many taxpayers who had actually paid their taxes. The book of printed notices was not marked “paid” for many taxpayers who had received counter receipts. These records and the daily cash receipts reports (cash receipts journal) were available at the time the independent auditors performed the most recent annual audit in April.

To keep his fraud going and prevent auditors from detecting it, Shelstad persuaded the auditors that the true “receivables” were the delinquencies turned over to the region’s legal counsel. Their confirmation sample and other work were based on this population. Thus, confirmations were not sent to fictitious balances that Shelstad knew had been paid. When Shelstad resigned in August, a power surge permanently destroyed the hard drive where the receivables file was stored, and the cash receipts journals could not be found. When the new regional agency managers took over the tax assessment, they noticed that the total of delinquent taxes disclosed in the audited financial statements was much larger than the total turned over to the region’s legal counsel for collection and foreclosure.

AUDIT APPROACH ANALYSIS

Audit Objective: The auditors’ objective is to obtain evidence determining if the receivables for taxes (delinquent taxes) represent genuine claims collectible from the taxpayers.

Controls Relevant in the Municipal Tax Revenue Process: The municipal system for establishing the initial amounts of taxes receivable was fine.

Professional staff appraisers and the independent appraisal review board established the tax base for each property, and the municipal council set the price (tax rate). The computer system authorization for billing was validated on these two inputs.

The cash receipts system was well designed, calling for preparation of daily cash receipts report (cash receipts journal that served as a source input for computer entry). This report was always reviewed by the “boss,” Shelstad.

Unfortunately, Shelstad had the opportunity and power to override the controls and become both cash handler and supervisor. He made the decisions about sending delinquent taxes to the region’s legal counsel for collection, but the ones he knew to have been paid but stolen were withheld.

Required:

Describe in detail the audit procedures you would perform in this case. Consider tests of control, and substantive tests such as dual-purpose tests of transactions and/or tests of details of balance. In particular, identify the information that could have been obtained from confirmations directed to the real population of delinquent accounts receivable (i.e., including the ones that had been stolen by Shelstad). Which tests do you consider likely to detect Shelstad’s theft? Why?