Parmalat, one of Italy’s largest companies, is best known for its shelf stable milk products. The company filed for bankruptcy protection in December 2003 after a ten-year fraud that removed at least $17.4 billion from the company. The fraud was referred to as a Ponzi scheme in which company executives borrowed billions of dollars from investors around the world to cover up the company’s losses. As a result of the fraud, U.S. investors suffered one of their largest losses in foreign securities when the debt securities became worthless.

Deloitte & Touche SpA, the Italian arm of the international accounting firm

Deloitte & Touche, was hired as the Parmalat audit firm in 1999. At the end of the audit engagement in 2001, Parmalat’s audit committee requested Deloitte to reexamine its audit fee. The Deloitte office in Italy referred to the Parmalat audit as a “crown jewel for our organization worldwide.” To keep the prized audit client happy, Deloitte agreed to lower its audit fees. Auditors in Deloitte’s office in New Jersey, where the U.S. Parmalat office was located, found their audit fee reduced from $165 per hour rate to about $90 per hour. Many Deloitte offices were involved in the audit because Parmalat had business operations in at least thirty countries. The Deloitte working papers indicate that auditors outside of Italy frequently gave in to the wishes of the Italian auditor because they feared being fired by such an important client. Deloitte auditors of

Bonlat Financing Corporation, located in the Cayman Islands, a unit of Parmalat, expressed concern about the financial transactions recorded in Bonlat. Despite the warnings given by several Deloitte offices involved in the audit, the office in Italy continued to issue clean audit reports. Its Italian office warned auditors in the other Deloitte offices to avoid asking questions regarding the business operations at Bonlat to prevent Parmalat from being annoyed and ending its multimillion-dollar audit engagement with Deloitte.

Parmalat officials later acknowledged that they had created Bonlat to hide fraudulent business transactions, referring to it as a “virtual garbage can.” Audi-

tors at Deloitte in Italy missed an opportunity to expose one of Europe’s largest accounting frauds and to prevent shareholder loss when stock price declined. 5

a. Describe how the audit risk model might have helped the auditor perform the Parmalat audit.

b. Did the auditor control audit risk to an acceptably low level? Explain your answer.

c. What role would the risk of material misstatement have played in the audit decisions Deloitte made?

d. Did the auditor fail to ask Parmalat to correct the financial statements because the audit adjustments were quantitatively immaterial? Explain your answer.

e. What do you think of the request to keep audit fees low to please a multinational client?

f. What do you think of a request to avoid asking the client difficult questions because it might fire the auditor?