8Ed.sol2.6

8Ed.sol2.6 - CASE 2.6 CBI HOLDING COMPANY, INC. Synopsis...

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CASE 2.6 CBI HOLDING COMPANY, INC. Synopsis Ernst & Young audited the pharmaceutical wholesaler CBI Holding Company, Inc., in the early 1990s. In 1991, Robert Castello, CBI’s owner and chief executive, sold a 48% stake in his company to TCW, an investment firm. The purchase agreement between Castello and TCW identified certain “control-triggering” events. If one such event occurred, TCW had the right to take control of CBI. In CBI’s fiscal 1992 and 1993, Castello orchestrated a fraudulent scheme that embellished the company’s reported financial condition and operating results. The scheme resulted in Castello receiving bonuses for 1992 and 1993 to which he was not entitled. A major feature of the fraud involved the understatement of CBI’s year-end accounts payable. Castello and several of his subordinates took steps to conceal the fraud from CBI’s Ernst & Young auditors and from TCW (two of CBI’s directors were TCW officials). Concealing the fraud was necessary to ensure that Castello did not have to forfeit his bonuses. Likewise, the fraud had to be concealed because it qualified as a “control-triggering” event. This case examines the audit procedures that Ernst & Young applied to CBI’s year-end accounts payable for fiscal 1992 and 1993. The principal audit test that Ernst & Young used in auditing CBI’s accounts payable was a search for unrecorded liabilities. Although Ernst & Young auditors discovered unrecorded liabilities each year that resulted from Castello’s fraudulent scheme, they did not properly investigate those items and, as a result, failed to require CBI to prepare appropriate adjusting entries for them. A subsequent lawsuit examined in detail the deficiencies in Ernst & Young’s accounts payable-related audit procedures during the 1992 and 1993 CBI audits. Following a 17-day trial, a federal judge ruled that Ernst & Young’s deficient audits were the proximate cause of CBI’s bankruptcy and the resulting losses suffered by TCW and CBI’s creditors.
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121 Case 2.6 CBI Holding Company, Inc. CBI Holding Company, Inc.—Key Facts 1. In 1991, TCW purchased a 48% ownership interest in CBI from Robert Castello, the company’s owner and chief executive. 2. The TCW-CBI agreement identified certain “control-triggering events;” if one of these events occurred, TCW would be permitted to take control of CBI. 3. During CBI’s fiscal 1992 and 1993, Castello oversaw a fraudulent scheme that resulted in him receiving year-end bonuses to which he was not entitled. 4. A major feature of the fraud was the understatement of CBI’s year-end accounts payable. 5. Castello realized that the fraudulent scheme qualified as a control-triggering event. 6.
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This note was uploaded on 09/15/2011 for the course ACT 442 taught by Professor Nancy during the Spring '11 term at Ohio State.

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8Ed.sol2.6 - CASE 2.6 CBI HOLDING COMPANY, INC. Synopsis...

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