Posted at 11.01.2018
Question: What specific mistakes (apart from failure to notice "warning flag") performed the auditor make? For every mistake, describe the particular auditor should have done. If you were the Managing Partner for the CPA organization and possessed full knowledge of all the reality and events in this case, what changes in insurance policy or procedures will you implement to be sure this audit inability does not arise in the future?
The Crazy Eddie's financial assertions had many fraudulent over and understatements done in many ways that the auditors should have found. They created fictitious earnings by lots of means. They ready phony invoices displaying sales which overstated their revenues to show the business was growing faster than they actually were. Their distributors collaborated in the fraudulence by lying down to the auditors when the auditors attemptedto confirm many of these receivables. The auditors weren't diligent when they verified these invoices. They must have probed further into the vendors to confirm these sales occurred. They also should have known the partnership between Cray Eddie's and their suppliers to understand if there were motives for scam.
They overstated their belongings by overvaluing inventory. They would borrow merchandise from suppliers to inflate the closing inventory. The suppliers would dispatch the item to the Crazy Eddie's stores and contain the billing until following the end of the accounting period. The employees of Crazy Eddie went to great extents to deceive the auditors. They might move inventory to the stores or warehouses which were being audited to conceal the shortages. The auditors should have caught that the merchandise was not billed and grasped what accounts they charged in the literature when the item was received. Another method of overstating the inventory was they transported inventory in one store to some other store so it could be dual counted. This should have been captured by the auditors by having the entire inventory verified in parallel. The employees contained in their inventory consigned goods and goods being returned to suppliers. This may have been found by understanding the facts of Crazy Eddie's inventory. The auditor must have recognized the consigned items and goods being go back to separate it from the standard inventory.
Crazy Eddie used the accounting intervals to overstate investments and income. They kept off shutting the books past the end of the accounting period to overstated possessions and income by boosting sales. The other means used was to reduce liabilities and bills by not recording them until the next period. The auditors must have verified books at the end of the accounting periods to be sure that all orders were registered. The auditors had a need to verify the trades around the finish of the period to check their timing precision.
Another category of deceptive activities was when they were completing their financial statements. They didn't effectively disclose facts in the financial statements relating to GAAP. The footnote during one period stated that certain income was regarded when received and the following period disclosed that income was identified when earned. The auditors must have added an explanatory paragraph or an adjustment of wording for lack of consistent program of GAAP.
Main Hurdman was the auditor for the business's annual audits and its consulting division was charging Crazy Eddie huge amount of money to computerize Crazy Eddie's inventory system. This violates guideline 102 for integrity and objectivity. Auditors can't objectively audit a listing system they developed which means this is a issue of interest. They should have chosen to develop the inventory system or be the auditor but not both.
Crazy Eddie's employees later stopped using the computer centered inventory system designed by Main Hurdman and used their manual inventory system. The auditors should have recognized the change in the inventory system used and known why they evolved. This will have been a signal that they were removing a few of the quality controls in the inventory system.
Many of Crazy Eddie's accountants were former members of Main Hurdman accounting company. The SEC added a requirement in the Sarbanes-Oxley Action that requires an associate of the audit team not work at your client for one-year in certain key management positions. The firm is not independent with respect to the audit client when a former auditor allows employment with your client.
There were several reported situations where the auditor requested the client documents and were advised that those documents were lost or inadvertently destroyed. Sarbanes-Oxley Act claims that working paperwork must be maintained for 7 years. The inadvertent destruction of working papers that are significantly less than 5 years has a charges of a decade in prison.
The collusion of key staff at Cray Eddie's managed to get very difficult for auditors to discover the fraud. When the auditors would have done a risk analysis prior to interesting with your client they would have identified a risk with so many members of the family employed at the company.
The success and progress rate of Crazy Eddie was not normal. The auditors should have completed a comparative examination of other digital retailers. This might show that their high progress rate wasn't typical compared to others. This would have prompted the auditor to look better at why they were outperforming the competition.
To prevent the CPA firm from having this occur in the foreseeable future, they need to follow the components of quality control. The one element is the plans and procedures before receiving or continuing a new client relationship. They must complete a client evaluation form which includes evaluation of the client's management. If this was done in the Crazy Eddie's circumstance, they might have discovered that it was a high-risk client predicated on his offering techniques together.
The company should follow the element of staff management where all new employees should be trained to execute their work competently. The personnel should have enough training and proficient. The field auditors for Crazy Eddie's were young and inexperienced. The management team was able to manipulate and affect the auditors.
The auditor needs to follow the procedure of verifying the inventory count number by observing it. Safety measures must be taken to avoid allowing the inventory to be changed by verifying it in parallel if multiple locations can be found. Crazy Eddie's auditors were fooled by not taking safeguards to avoid double keeping track of the inventory.
The firm are required to follow the Generally Accepted Auditing Expectations. Among the requirements of field work is to obtain a sufficient understanding of the entity and its environment including its internal control. If this is done, the auditors could have observed that Crazy Eddie had impact over his suppliers to cooperate in inflating the possessions. The change in the inventory system back to the manual system proved a lack of interior control.
The firm must follow the guidelines of conduct. They need to keep their objectivity by not providing other services such growing or advising a listing system. They must remain self-employed by not auditing a client that has previous associates of the audit team working at your client within one-year.