Discussion Topic: Audit Failures

The purpose of the audit is to provide assurance as to the accuracyof financial statements. Situations such as the Enron collapse, whichwere largely due to the failure of an auditor to detect fraud and evenconcealed it, led to significant public unrest and market failure.Discuss an article involving audit failure and how it led to publicunrest. Also, when evaluating the article referenced, discuss how audittesting should have uncovered audit failure.

Also response each posted # 1 to 3 down below

Posted 1

BarryMinkow founded the “insurance restoration” company ZZZZ Best. With thehelp of an insurance claim adjuster friend (Tom Padgett), Minkow formeda fake company called Interstate Appraisal Service which verifieddetails of the fake insurance restoration contracts. George Greenspan,CPA, audited ZZZZ Best in 1986 and failed to visit any of the insurancerestoration sites. The “sites” were actually random mailboxesthroughout the San Fernando Valley. Greenspan received the bulk of hisaudit evidence though interviews and documentation obtained fromInterstate Appraisal Service, the party to substantially all thereported restoration contracts. ZZZZ Best’s restoration business was asham and Padgett and Minkow worked together, along with otherco-conspirators who had ties to organized crime, to defraud lenders andinvestors out of millions of dollars. Ernst and Whinney was laterretained as ZZZZ Best’s accountant in September of 1986 when the companywanted to go public. Ernst and Whinney conducted a review of Best’sfinancial statements for the three-month period ended July 31, 1986 toassist ZZZZ Best with its public filings.

Aspart of audit procedures (for the 1987 audit), an Ernst and Whinneypartner visited an insurance restoration site (after being denied thevisit several times initially) which was a building ZZZZ Best rented outto continue the fraud. ZZZZ Best added signs; “hired” phony staff;paid the security guards at the building to be complicit; and madeErnst and Whinney sign a non-disclosure agreement where the firm agreednot to contact the building owner, contractors, insurance adjusters,etc. regarding the restoration project. The firm also agreed that thepartner would be the only firm representative allowed on the tour andagreed not to disclose the location of the building, severely limitingthe scope of the audit. Later, Ernst and Whinney discovered evidence offraud (mostly through the media and an informant) at ZZZZ Best andresigned. They did not disclose the reason for the resignation to theSEC for six weeks, which was allowed. In the meantime, ZZZZ Bestcontinued to defraud banks and investors before the company wentbankrupt.

Greenspanshould have conducted restoration site visits as part of his audittesting. Additionally, he should have approached the relationshipbetween Interstate and ZZZZ Best with a more critical eye. Ninetypercent of the insurance restoration contracts and related revenue ZZZZBest reported were from Interstate. The internal controls at ZZZZ bestwere grossly inadequate – proper testing would have alerted theauditor. Contracts consisted of a single page with no details or otherspecifications which should have raised a red flag. The contracts didnot identify the insured parties, the insurance companies or thelocations of the job. Greenspan did not question the information, nordid he contact the insurance companies or the insured parties to confirmdetails of the contracts. The number of multimillion-dollarrestoration contracts exceeded the total number available nationwide forthat time period. Additionally, the amounts of the restorationcontracts were unusually large. Had Greenspan spent time understandingthe industry, he would have discovered this. Additionally, reviewingthe changes in financial ratios from year to year would have given someindication of accounting irregularities. For instance, the currentratio of assets to liabilities went from 36 in 1985 to less than 1 in1986 meaning the company had no cash despite showing record revenues.The 1986 debt to equity ratio was up 8600% from the prior year. Thesewere not indicators of a legitimate business and should have alertedGreenspan to something in the milk not being clean.

Eventhough Ernst and Whinney did not complete their audit, had they donetheir due diligence they never would have accepted ZZZZ Best as aclient. The company management had no experience; some managers andbusiness partners had ties to organized crime; and Minkow had a past offorgery and bank fraud. Additionally, once Minkow tried to keep Ernstand Whinney from visiting its restoration sites and only allowed it whenthe company could limit the scope of the audit, Ernst and Whinney should have known something was amiss. Additionally, Greenspan statedhe was never contacted by the successor auditor which is an auditrequirement.

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

Thearticle that I chose talks about a very recent audit failure in theaudit of the Germany-based Wirecard AG, which was one of the biggest andfastest-growing European fintech. EY audited Wirecard for over a decadeand failed to obtain sufficient audit evidence on the € 1.9 billionbelonging to the company that was supposed to be held in trust accounts(Davies, 2020). The company filed for bankruptcy in June 2020 afterconfirming that the € 1.9 billion it had listed as assets probablydidn’t exist.

Afterthis event, EY has faced widespread criticism because of its failure toproperly 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 wereimproperly booked on the company’s 2018 accounts. Because of thissituation, EY Chairman had to send a letter to clients to explain aboutthis failure.

Inmy opinion, the auditors failed to properly access the reliability ofthe bank confirmation received during the audit. The audit plan shouldhave considered the form of the confirmation requested, as well as theintended respondent and the nature of the information being confirmed.Additionally, in situation involving significant transactions orbalances the auditor should exercise a heightened degree of professionalskepticism 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

Inthe article, “WeWork: Auditor EY didn’t warn about the risks”, thewriter points out that EY’s client, WeWork, did not disclose materialweaknesses in the company’s financial reporting internal controlprocesses (McKenna, 2019). The article explains the public concern ofWeWork’s canceled IPO and the conflicts of interest within therelationships with WeWork’s CEO and the companies WeWork leasesproperties from.

EY did not find those relationships to be risks during their auditrisk assessment procedures at WeWork. The relationships had directconflicts of interest because WeWork executives had direct financialbenefit 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