FRAUD PROFESSIONAL SKEPTICISM Cenco Medical Health Supply Corporation (CMH) was an SEC- registered company that went bankrupt after it had materially misstated its nancial statements for a number of years. It inated the reporting of its physical inventory by 50% during two years prior to its bankruptcy. The fraud was perpetrated by \"( 1} altering the quantities recorded on the presnumbered, two part inventory tags used in counting the inventory; {2} altering documents reected on a computer list prepared to record the physical count of inventory; and (3) creating inventory tags to record quanties of nonexistent inventory.\" The SEC asserted that the auditors should have detected the fictitious inventory but did not because the audit firm \"left the extent of various observation testing to the discretion of auditors. not all of whom were aware of signicant audit planning that should have related directly to the extent ofsuch testing. Observation of inventory counts at year end was conned to six locations (representing about 40% of the total CMH inventory) as opposed to nine in the preceding year. The eld auditors did not adequately control the inventory tags and the auditor did not detect the creation of bogus inventory tags which were inserted in the nal inventory computations." The SEC was also critical of the audit rm for assigning interns to a significant portion of the inventory observation without training them in the nature of the client's inventory or its counting procedures. This is an example of a situation in which auditors' lack of professional skepticism led to low audit quality and a subsequent audit failure. Source: R. W ll Dickenson, \"Why the Fraud Went Undetected,\" CA Magazine April 1977, pp. (SW69. The SEC alleged that many deciencies occurred during the audit of CMH. Among the complaints were the following: 1. The audit rm \"left the extent of various observation testing to the discretion of auditors, not all of whom were aware of significant audit conclusions which related directly to the extent of such testing. Observations of inventory counts at year end were conned to six locations (representing about 40% of the total CMH inventory) as opposed to nine in the preceding year. The field auditors did not adequately control the inventory tags and Seidman 8r Seidman [the auditor] did not detect the creation of bogus inventory tags which were inserted in the nal inventory computations.\