430 exam 2 cases

Ligand pharmacuticals what went wrong

• High inherent risk: revenue with a right of return needs a reserve estimate, the products were new (little history), and the wholesalers were slow to provide data.

• Pressure: the stock soared without ever showing an operating profit.

• Management bias in an estimate: management used a 2.5% return rate when the data showed 13% to 20%.

Ligand pharmacuticals audit wrong

• Planning: good. Deloitte rated it “greater than normal” engagement risk and identified sales returns as the problem.

• Execution: bad. The auditors didn’t review the updated wholesaler data, ignored the history of underestimates, lacked skepticism and due care, and supervised poorly. The partner knew the reserve looked low and signed anyway. When Q1 2004 data again showed the problem, he didn’t recommend restatement (subsequent events and discovery).

• Firm level: Deloitte thought the partner was a “quality risk” and kept him on the audit (quality control).

General motors what went wrong

• High inherent risk: the pension discount rate is a discretionary estimate with a material effect on earnings and equity.

• Management bias: they picked 6.75% over their own method (6.0%) and their actuary’s number (6.18%), because a higher rate lowers the liability and expense.

• Misleading disclosure: the sensitivity analysis made 6.75% look like the midpoint, and they didn’t disclose the unconventional method (presentation and disclosure assertion).

General motors audit wrongness

• Planning / initial response: good. The auditors treated the rate as a key area, thought 6.75% was too high, held two meetings, and insisted the actuary attend.

• Execution: bad. They caved to a disclosure “compromise” instead of requiring correction, accepted the unsupported claim that “most companies use Moody’s,” ignored the specialist’s number, and issued a clean opinion even though the partner thought 6.5% was better.

Leslie Fay what went wrong

• Fraud triangle: pressure (record earnings in an industry slump, analysts, executive bonuses and stock), opportunity (dominating CFO, remote accounting office, weak oversight, slow computerization), rationalization (not detailed).

• Weak control environment and tone at the top: an intimidating CFO who made a subordinate take the blame.

• Fraud schemes: inflated inventory (forged tags, bogus in-transit stock), pre-recorded sales, unrecorded expenses, no write-offs of uncollectible receivables, and a gross margin forced to look like 30% when it was about 20%.

• Management oversight failure: Pomerantz didn’t pursue red flags and benefited from the results.

Leslie Fay audit wrongness

• Planning: the case doesn’t show BDO’s plan, but the red flags were visible at planning: unusually stable margins, record results when peers struggled, and bonuses tied to earnings. These should have raised fraud risk.

• Execution: bad (per the Stillman report, likely negligent). The count didn’t catch forged tags and phantom inventory, analytical procedures didn’t prompt follow-up on the stable margin, and cutoff and receivables weren’t challenged enough.

• Independence: lawsuits led BDO to resign.

Madoff securities what went wrong

• Extreme inherent risk: a dominant founder who controlled custody and records, a secret “black-box” strategy, returns that were too consistent, no online account access, and feeder funds.

• The fraud: a Ponzi scheme with fictitious returns and statements. Madoff’s “it’s been audited” deflected skeptics.

Madoff securities audit wrongness

• Bad from the start. The “auditor” was one accountant, a secretary and a 200-square-foot office, with no capacity to audit a firm that size (competence, AS 1010).

• Independence violation: he had about $15 million invested with Madoff (AS 1005).

• No peer review, because he reported performing no audits to the AICPA (quality control).

• Existence of assets was never independently verified (no confirmation with custodians, no real testing).

• Feeder fund auditors: they should have checked out Madoff’s auditor (reliance on others), and some were held liable.

Navistar what went wrong

• Weak internal controls: too few trained accountants, no written policies, organizational flaws, and 15 material weaknesses (control deficiencies).

• Aggressive accounting: warranty reserve reduced by anticipated vendor reimbursements, vendor rebates on expected future purchases, and deferred start-up costs.

• Pressure not to revise announced earnings.

Navistar audit wrongness

• Detection: good (the audit team found $20 million of errors in the finance subsidiary). Evaluation and response: bad.

• Planning materiality changed at the last minute (5% to 7.5%) so a $4.5 million error would be “presumptively immaterial,” plus accepted deferring a write-off without a GAAP basis.

• Documentation: an inaccurate workpaper.

• Reliance on management representations and a firm culture lacking critical analysis.

• Independence: alleged to be a “de facto adjunct” of the accounting department, with consulting on accounting structure; also a 98-year tenure.

• Later, a replacement partner was properly skeptical and restarted the audit.

CBI holding what went wrong

• Control risk factors: a dominant CEO, no internal audit, poor segregation of duties, aggressive estimates, and an ineffective control environment.

• Incentives: CEO bonus tied to earnings, and a control-triggering event in the TCW agreement gave him a reason to hide problems.

• Fraud: understated accounts payable (about $2 million in 1992 and $7.5 million in 1993), disguised as “advances” with fake supporting documents.

CBI holdings audit wrongness

• Planning: good. E&Y called it a “close monitoring engagement,” documented the control risks and rated accounts payable high risk. The audit program included the right procedures: search for unrecorded liabilities and reconcile vendor statements for the largest vendors. Planned they would test top 10 vendors but didnt’, tested a few small ones

• Execution: bad. They accepted the “advances” explanation without evidence (didn’t check the credit limit, analyze vendor accounts, contact vendors, or determine when goods were received). They never identified the largest vendors and tested a few small ones, so the completeness testing failed. Reconciling Burroughs-Wellcome would have caught it.

• Independence: the partner let the client remove a probing manager, was slow to follow up on the CFO’s resignation, cared about fees, and hid the audit flaws from the board to win the reaudit.