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Auditing Cases: An Interactive Learning Approach (4th Edition)

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Unformatted text preview: Phar- Mor Case This free essay has been submitted by: Nikunj Patel Total words: 2139 Company Data: IV. Phar Mor Issues: 1. The Phar- Mor case involves a fraud perpetrated by its management team. Although, according to the case, there were no claims that the auditors participated in the fraud, plaintiff's attorneys were able to convince the jury that Phar- Mor was liable for fraud. They alleged that Cooper & Lybrand made representations recklessly with regard to GAAS and GAAP. 2. Accounting Issues: Related party transactions Inadequate MIS Systems Inventory recognition Auditing Issues: Negligence Liability for investor and creditor losses 3. Requirements: Identify engagement between the auditor and client Distinguish power imbalance between auditors and clients Determine from an investor's viewpoint whether it is logical to pursue legal action Comprehend difference between negligence, fraud and recklessness Verify auditor's liability according to Ultramares Doctrine Discuss Securities Acts of 1933 and 1934 Detecting Inventory fraud Recognize "High Risk" factor clients ree V. Opinion stu Violation of Code of Professional Conduct de nte du 1. Business product/ service: Variety of Household products and prescription drugs 2. Industry: Discount retail chain 3. Comparable public companies: Wall- Mart, K- Mart, Target, other discount retail stores 4. Other data: Phar- Mor's strategy was to undersell any discount retail chain store like Wall Mart in each market where the retailers directly competed. Phar- Mor understated their costs of goods sold while overstating inventory and income. .co m •1. a. We believe that poor internal control within the company and inadequate MIS systems were key to the level of fraud that management had reached over a period of six consecutive years. b. This case clearly shows that auditors that take part in fraud are likely to be held liable for the losses of investors and creditors regardless of whether or not they have knowledge of the fraud even if the engagement was conducted in a responsible manner c. To avoid the issues raised in the case, Phar- Mor should have adapted adequate accounting practices. ?????????? Jaime please help!!!! ;0) VI. Answers to Case Requirements 1. (a) A company would want to hire a member of its external audit team for the following reasons: They have an insight to the company's business and the industry. The external member wouldn't have to be trained since it knows the business. The company has seen the type of work the auditor can produce and have a good working relationship. The external auditor would have knowledge of the audit, which would reduce any risk the company could have in case of an illegal or inappropriate accountability in their financials. ree (d) An auditor cannot take the word of executives on pure trust. The auditor must conduct an unbiased viewpoint when performing audit tests, evaluating the results and issuing the audit report regardless of whom they are dealing with. Auditors do have to heavily rely on management and must ascertain that management is trustworthy. As stated in the "Opinion", the financial statements are the responsibility of management. Therefore, a comfortable level of trust between management and auditor must exist. 2. (a) Diverse factors of the auditor- client relationship can place the client in a powerful position in relation to its auditors. Primarily, the firm is providing a service to the client and the client decides whether or not to rehire the same auditor the following years. If the auditing firm is looking for long- term relationship with the client they often do not want to disappoint them in order to be recommended to further businesses. Indirect financial factors, (i.e. acquiring of new business clients from the recommendations of current clients), may also exist if there is an stu (c) With respect to the AICPA Code of Professional Conduct if a client offers an auditor a job while an audit engagement is ongoing, it is extremely important that the external auditor remain objective and free of any type of independence conflicts throughout the engagement. By offering the auditor a job, this independence becomes breached and the external auditor no longer has objectivity. As a result, both parties may have alternate motives. de (b) Hiring former auditors is not illegal but there are procedures depending on specific facts and circumstances for the company to stay independent. First, they must verify if the auditors served on the engagement team and for how long. Also, they must know what positions were held with the auditing firm, positions they are acquiring and the key point, the amount of time that has passed since the auditor left the firm. There is a one- year "cooling off" period required if the auditor is considering certain key management positions (CEO, CFO, CAO, Controller or any other equivalent position). The CPA firm cannot continue to audit the client if the auditor accepts within one year of the audit finish date. nte du .co m (b) A case that involves negligence is one in which the auditor clearly failed to exercise due professional care. Negligence typically does not include minor errors and imprecision; rather it occurs from an omission or by an action. (c) Negligence and fraud are both degrees of improper performance. A case that involves fraud is one in which there is an intentional misstatement of material fact that may wrong another party based upon reliance. Thus, the primary difference between negligence and fraud is intent. While recklessness also involves intentional misstatement of material, it differs from fraud in that is a lesser form of intent. Recklessness does not stress the intentions of the accountant to take part in the fraud. Rather, it questions whether the accountant violated pertinent accounting standards. The auditors must have been aware that the financial reports were to be used for a particular purpose or purposes In the furtherance of which a known party or parties was intended to rely on There must have been some conduct on the part of the auditor linking them to that party or parties, which evidences the auditor's understanding of that party or party's reliance. In order for a third party to recover damages from an auditor for actual or constructive fraud, the third party must show that he or she reasonably relied on the accountant's work. On the other hand, there is no need for the third party to show privity of contract in the case of fraud or gross negligence. •(b) The Rusch Factors jurisdictions differ from Ultramares doctrine because it extends accountants' liabilities for negligence to third parties who are not in privity of contract with the accountant. Any third parties to whom the accountant supplies the work and any third parties or groups identified by the client as intended recipients of the work, will have a cause of action for negligence. ree 5. The purpose of the Securities Act of 1933 is to require that investors and creditors receive "material" information regarding securities offered for public sale, and to prohibit any fraudulent representation in the sale of such securities. The purpose of the Securities Act of 1934 was to expand federal regulation to trading in securities that are already issued and stu de 4. (a) The Ultramares doctrine is a statute that holds an accountant liable for negligence to third parties who are in privity of contract or a privity like relationship with the accountant. It provides the narrowest standard for holding accountants liable to third parties for negligence. Therefore, before auditors may be held liable in negligence to third parties who are not primary beneficiaries, certain prerequisites must be satisfied: nte du 3. (a) If we were equity investors, we would in- fact pursue legal action against the auditor. Taking legal action against auditors who participate in accounting fraud is a form of warning to the accounting society, which proves how important the integrity of audited financial statements is for investors. As an investor, I must bear the business risk involved with Phar- Mor; however, information related to the fraudulent statements should not jeopardize an investor. Additionally, it appears that Coopers was aware of the recklessness with the reported financial situations of Phar- Mor. Thus, the plaintiff i.e. the investor may be able to prove that the auditors acted with reckless disregard for the truth. .co (b) The potential consequences of this power imbalance can be significantly reduced by complying with the rules specified under the Sarbanes- Oxley Act of 2002. For one, the risk of audit failures from longterm relationships can be limited by the five- year rotation cycle stated under Section 203 of the Sarbanes- Oxley Act. Need more??????? m Diverse factors of the auditor- client relationship can place the client in a powerful position in relation to its auditors. Primarily, the firm is providing a service to the client and the client decides whether or not to rehire the same auditor the following years. If the auditing firm is looking for long- term relationship with the client they often do not want to disappoint them in order to be recommended to further businesses. Indirect financial factors, (i.e. acquiring of new business clients from the recommendations of current clients), may also exist if there is an ownership interest between both auditor and client. Factors such as these overpower the company's auditors. As these Acts relate to auditor liability, according to Securities Exchange Act of 1933, Section 11(a) (4): On the other hand, only the issuer will be held liable if the auditor, who shall sustain the burden of proof, had resigned as permitted by law or had advised the SEC that he would not be responsible for a part of the registration statement by the effective date. In the 1934 Act there is also an Auditor Liability limitation that states: "No registered public accounting firm shall be liable in private action for any...statement expressed in a report...", if they have not failed to notify the commission or report after registration. Penalties under the 1933 Act include fines up to $10,000, imprisonment up to 5 years or both. In the 1934 Act, an individual may be fined up to 1 million dollars and 10 years in prison. (b) Auditors give advance notice as to specific locations where they would observe the inventory. As a result of this advance notice, the client could make fraudulent adjustments at other locations that were not tested. Also, clients can add fake inventory to items that weren't tested, causing inventory values to increase. Phar- Mor's inventory compilations contained fraudulent Journal entries with suspicious account names such as Accounts receivable Inventory contra and "Cookies". These entries were used to inflate inventory. "Bucket" accounts were used to offset the compilation results of which were cleared and allocated to individual stores as inventory or other assets. The fraud team at Phar- Mor was aware that the zero balance accounts draw very little attention. (c) Obserservation Physical inventory Management representatives should not follow the auditor and record the test counts. Auditors should take an extra step in examining packed boxes. Management might stack empty boxes in the warehouse to inflate inventory. ree Analytical Procedures When comparing previous period books sales will be too low ; inventory and profits will be too high. Decrease in inventory turnover Inventory rising faster than total assets move up. Falling costs of sales as percentage of sales. stu de 6. (a) Other High Profile Cases: Comptronix Corp., Laribee's nte du "In case any part of the registration statement...contained an untrue statement of material fact or omitted to state a material fact...necessary to make the statements therein not misleading, any person acquiring such security...may, either at law or in equity...sue- every accountant...or any person whose profession gives authority to a statement made by him...or as having prepared or certified any report or valuation which is used in connection with the registration statement..." .co Both the Securities Exchange Acts of 1933 and 1934 were implemented to regulate the sale of securities. Though their primary objective is very similar, the 1934 Act is a more inclusive decree and regulates secondary markets and their participants. On the other hand the Act of 1933 mainly emphasizes the required registration process of securities and makes it illegal to commit fraud in connection with the sale of securities. m The purpose of the Securities Act of 1933 is to require that investors and creditors receive "material" information regarding securities offered for public sale, and to prohibit any fraudulent representation in the sale of such securities. The purpose of the Securities Act of 1934 was to expand federal regulation to trading in securities that are already issued and outstanding. This Act formed the SEC, granting it the authority over all aspects of the securities trade and markets. 7. (a) Phar- Mor was engaged in hard to reconcile accounting practice as was the case with the Tamco settlement of 7 million dollars. Phar- Mor had no way of determining the exact amount of storage because Phar- Mor didn't log shipments made by Tamco. All images, coding, free essays, free term papers, free research papers, free book reports, rate professors, rate your professors, rate schools, all pages and data cannot be used without the prior written consent of this website. Copyright © 2008 Free Student Education. All rights reserved. Privacy Policy / Disclaimer ree stu de nte du •(b) Auditing standards state that the auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. Fraud, from the auditor's perspective, involves intentional misstatements that can be classified into two types: (1) misstatements arising from fraudulent financial reporting and (2) misstatements arising from misappropriation of assets. Auditors therefore should be held responsible, regardless of whether the material misstatement was due to errors or fraud. .co Pricing strategies: Phar- Mor used a one standard cost factor while at the same time employing a variety of pricing strategies. Cooper's price test resulted in wide range of gross margins resulting from items sold below cost margins. Presence of unusual transactions: Entries were unusual and had no explanations or any supporting documents. At the end of the year numerous "blow out" entries were recorded in last monthly corporate GL. A susceptibility of the account balance to adjust: To avoid auditors' detection, "bucket" accounts were emptied and allocated back to stores as inventory or assets. Some account names were labeled as "accrued inventory" and "Allocation of Inventory". m ...
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This document was uploaded on 04/06/2010.

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