Grossly Inadequate Proper Stanford University Th
Discussion Topic: Audit Failures
The purpose of the audit is to provide assurance as to the accuracy
of financial statements. Situations such as the Enron collapse, which
were largely due to the failure of an auditor to detect fraud and even
concealed it, led to significant public unrest and market failure.
Discuss an article involving audit failure and how it led to public
unrest. Also, when evaluating the article referenced, discuss how audit
testing should have uncovered audit failure.
Also response each posted # 1 to 3 down below
Posted 1
Barry
Minkow founded the “insurance restoration” company ZZZZ Best. With the
help of an insurance claim adjuster friend (Tom Padgett), Minkow formed
a fake company called Interstate Appraisal Service which verified
details of the fake insurance restoration contracts. George Greenspan,
CPA, audited ZZZZ Best in 1986 and failed to visit any of the insurance
restoration sites. The “sites” were actually random mailboxes
throughout the San Fernando Valley. Greenspan received the bulk of his
audit evidence though interviews and documentation obtained from
Interstate Appraisal Service, the party to substantially all the
reported restoration contracts. ZZZZ Best’s restoration business was a
sham and Padgett and Minkow worked together, along with other
co-conspirators who had ties to organized crime, to defraud lenders and
investors out of millions of dollars. Ernst and Whinney was later
retained as ZZZZ Best’s accountant in September of 1986 when the company
wanted to go public. Ernst and Whinney conducted a review of Best’s
financial statements for the three-month period ended July 31, 1986 to
assist ZZZZ Best with its public filings.
As
part of audit procedures (for the 1987 audit), an Ernst and Whinney
partner visited an insurance restoration site (after being denied the
visit several times initially) which was a building ZZZZ Best rented out
to continue the fraud. ZZZZ Best added signs; “hired” phony staff;
paid the security guards at the building to be complicit; and made
Ernst and Whinney sign a non-disclosure agreement where the firm agreed
not to contact the building owner, contractors, insurance adjusters,
etc. regarding the restoration project. The firm also agreed that the
partner would be the only firm representative allowed on the tour and
agreed not to disclose the location of the building, severely limiting
the scope of the audit. Later, Ernst and Whinney discovered evidence of
fraud (mostly through the media and an informant) at ZZZZ Best and
resigned. They did not disclose the reason for the resignation to the
SEC for six weeks, which was allowed. In the meantime, ZZZZ Best
continued to defraud banks and investors before the company went
bankrupt.
Greenspan
should have conducted restoration site visits as part of his audit
testing. Additionally, he should have approached the relationship
between Interstate and ZZZZ Best with a more critical eye. Ninety
percent of the insurance restoration contracts and related revenue ZZZZ
Best reported were from Interstate. The internal controls at ZZZZ best
were grossly inadequate – proper testing would have alerted the
auditor. Contracts consisted of a single page with no details or other
specifications which should have raised a red flag. The contracts did
not identify the insured parties, the insurance companies or the
locations of the job. Greenspan did not question the information, nor
did he contact the insurance companies or the insured parties to confirm
details of the contracts. The number of multimillion-dollar
restoration contracts exceeded the total number available nationwide for
that time period. Additionally, the amounts of the restoration
contracts were unusually large. Had Greenspan spent time understanding
the industry, he would have discovered this. Additionally, reviewing
the changes in financial ratios from year to year would have given some
indication of accounting irregularities. For instance, the current
ratio of assets to liabilities went from 36 in 1985 to less than 1 in
1986 meaning the company had no cash despite showing record revenues.
The 1986 debt to equity ratio was up 8600% from the prior year. These
were not indicators of a legitimate business and should have alerted
Greenspan to something in the milk not being clean.
Even
though Ernst and Whinney did not complete their audit, had they done
their due diligence they never would have accepted ZZZZ Best as a
client. The company management had no experience; some managers and
business partners had ties to organized crime; and Minkow had a past of
forgery and bank fraud. Additionally, once Minkow tried to keep Ernst
and Whinney from visiting its restoration sites and only allowed it when
the company could limit the scope of the audit, Ernst and Whinney
should have known something was amiss. Additionally, Greenspan stated
he was never contacted by the successor auditor which is an audit
requirement.
References
Wells, J.T., (2001). Irrational rations. Retrieved from https://www.journalofaccountancy.com/issues/2001/aug/irrationalratios.html
Gaines, S., (1988). In fraud case, CPA practices on trial. Retrieved from https://www.chicagotribune.com/news/ct-xpm-1988-01-31-8803260897-story.html
Posted 2
The
article that I chose talks about a very recent audit failure in the
audit of the Germany-based Wirecard AG, which was one of the biggest and
fastest-growing European fintech. EY audited Wirecard for over a decade
and failed to obtain sufficient audit evidence on the € 1.9 billion
belonging to the company that was supposed to be held in trust accounts
(Davies, 2020). The company filed for bankruptcy in June 2020 after
confirming that the € 1.9 billion it had listed as assets probably
didn’t exist.
After
this event, EY has faced widespread criticism because of its failure to
properly audit Wirecard’s accounts over several years (Aaron, 2020).
The accounting firm was also sued in Germany by the company’s investors,
which alleged that EY failed to identify that the assets were
improperly booked on the company’s 2018 accounts. Because of this
situation, EY Chairman had to send a letter to clients to explain about
this failure.
In
my opinion, the auditors failed to properly access the reliability of
the bank confirmation received during the audit. The audit plan should
have considered the form of the confirmation requested, as well as the
intended respondent and the nature of the information being confirmed.
Additionally, in situation involving significant transactions or
balances the auditor should exercise a heightened degree of professional
skepticism about the respondent.
References
Aaron, Tony (2020, Sep 15). Auditor EY Expresses ‘Regret’ Over Failures After Wirecard Collapse. Bloomberg (Online) Retrieved from https://www.bloomberg.com/news/articles/2020-09-15…
Posted 3
In
the article, “WeWork: Auditor EY didn’t warn about the risks”, the
writer points out that EY’s client, WeWork, did not disclose material
weaknesses in the company’s financial reporting internal control
processes (McKenna, 2019). The article explains the public concern of
WeWork’s canceled IPO and the conflicts of interest within the
relationships with WeWork’s CEO and the companies WeWork leases
properties from.
EY did not find those relationships to be risks during their audit
risk assessment procedures at WeWork. The relationships had direct
conflicts of interest because WeWork executives had direct financial
benefit from the companies they leased the properties from. Therefore,
EY failed to detect fraud in their audit of WeWork.
Reference:
McKenna, Francine (2019). WeWork: Auditor EY didn’t warn about the risks. Retrieved from: https://thedig.substack.com/p/wework-auditor-ey-didnt-warn-about