Academic journal article Journal of the International Academy for Case Studies

Auditor Skepticism, Management Biases, and the Slippery Slope

Academic journal article Journal of the International Academy for Case Studies

Auditor Skepticism, Management Biases, and the Slippery Slope

Article excerpt

CASE DESCRIPTION

The primary subject matter of this case concerns auditor skepticism and the ability to recognize signs of financial reporting fraud. Secondary issues include promoting an understanding of the environment where financial reporting fraud is likely. The case is developed for use in both undergraduate and graduate classes in accounting, forensics, or auditing. The case has been successfully used in undergraduate classes (levels 3 and 4) and in graduate classes (level 5).

CASE SYNOPSIS

The case, based on actual SEC fraud action filings, examines a company where the CEO exhibits strong signs of overconfidence. The CEO had a compelling belief in the success of the company that contrasted with the economic realities. When economic conditions did not support the achievement of goals he had promoted with stock analysts and with investors, he chose to alter financials to meet his goals rather than adjust downward his goals. He promoted within the firm a culture that rewarded employees who found ways to misreport financials. The audit firm who examined the financials missed major fraud that affected many accounts. The total amount of the fraudulent misstatement was estimated at $60 million or 64% above the proper pre-tax income. The case is written from the standpoint of the audit team. Students should identify with the new hire, Valerie, as Valerie struggles to explain audit evidence and with the audit in-charge, Luis, who must decide whether to investigate further (and incur higher costs) or accept the viewpoint of his superiors. The introduction from the audit manager's viewpoint forces students to acknowledge that audit failure has consequences for the auditors, the audit firm, the investors, and the audit client. Three years after the audit concludes the in-charge (now an audit manager) is forced to examine how the audit failure could have been prevented.

The case explores the role the CEO's association with the audit firm may have had on the level of professional skepticism in the auditors. The CEO had worked previously as a manager with the audit firm. Using the characteristics of professional skepticism recognized in the fraud literature, students are encouraged to examine how to assess professional skepticism in the audit. This case is intended to help students who later become audit professionals recognize threats to maintaining a high level of professional skepticism and acknowledge signs of potential financial reporting fraud. The case also examines the concept of the slippery slope where individuals who choose to commit one indiscretion continue to commit more--suggesting the initial ethical violation leads to further indiscretions. (In this case, both the CEO and employees faced a slippery slope.)

CASE BODY

Introduction: Delish Pasta Audit

Luis Ramez, the audit in-charge had just wrapped up the audit of Delish Pasta. He felt the audit went well. The audit workpapers were clean--all management's assertions about the financial statements had been confirmed. Jim, the audit manager, and John, the audit partner would have little difficulty issuing a clean audit report. His audit team worked well together. The new hire, Valerie, responded well to his guidance and he would use her on future audits.

Three years later, Luis' view of the audit was completely different. Delish Pasta was restating the financials. The Securities and Exchange Commission (SEC) estimated the overstatement of pre-tax income at approximately $60 million or 64% above the proper pre-tax income The SEC was investigating the restatement and the audit firm was facing class action lawsuits. Moreover, Luis was sitting outside John's office waiting for his exit interview. Sitting outside for what seemed like ages, Luis reflected on what went wrong. How could he have missed the obvious signs?

1. The CEO whom everyone trusted had committed major financial reporting fraud. …

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