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ACCT 4304, Fall 2015 Audit case Read the attached audit case and answer all the questions that follow. A total of 90 points are available for the actual responses to the questions and 10 points are available for presentation, clarity and grammar. Total points for the assignment are 100. Note: Answer the questions as comprehensively as possible. Reference to Auditing Standards, your textbook, and other relevant authoritative sources is expected where appropriate. Even where some of the questions are quite general, try as much as possible to relate your answer to the case. 1. Some of the members of Phar-Mor's financial management team were former auditors for Coopers & Lybrand. (a) Why would a company want to hire a member of its external audit team? (3pts) (b) If the client has hired former auditors, would this affect the independence of the existing external auditors? Explain. (3pts) (c) How did the Sarbanes-Oxley Act of 2002 and related rulings by the PCAOB, SEC or AICPA affect a public company's ability to hire members of its external audit team? (3pts) 2 (a) What factors in the auditor-client relationship can put the client in a more powerful position than the auditor? (3pts) (b) What measures has and/or can the profession take to reduce the potential consequences of this power imbalance? (3pts) (c) Do you believe that in this Phar-Mor Case there was some power imbalance between the Coopers and Phar-Mor? Explain. (3pts) 3. (a) Is it appropriate for auditors to trust executives of a client? Explain (3pts) (b) Identify 3 instances in the case where auditors apparently trusted the responses or explanations they were given by the client. For each instance, comment on whether or not it was appropriate to trust the client and if not, what the auditor could have done. (6pts) (c) Do you think that auditors should have equal responsibility to detect material misstatements due to errors and those due to fraud? Why or why not? Hint: Think about this from the perspective of what the purpose of an auditor is, what his responsibilities are and what kind of assurance he provides (4pts) 4. Discuss the conditions, attitudes, and motivations at Phar-Mor that created an environment conducive for fraud and could have been identified as red flags by the external auditors (5pts) 5. The popular press has indicated that inventory fraud is one of the biggest reasons for the proliferation of accounting scandals (a) What makes the intentional misstatement of inventory difficult to detect? (2pts) (b) How was Phar-Mor successful in fooling Coopers & Lybrand for several years with overstated inventory? (3pts) (c) Identify two management assertions that you would consider to have been most important in the audit of inventory for Phar-Mor. For each assertion, explain why it is important and how the auditors could have tested it. (9pts) 6 (a) The auditors considered Phar-Mor to be an inherently 'high risk' client. Briefly discuss two factors at Phar-Mor that would have contributed to a high inherent risk assessment. (4pts) (b)Inventory had been identified as being a specifically high-risk area. How should this have affected how the Coopers auditors carried out the audit of inventory? (consider timing, nature and extent of tests) (5pts) 7. In the case there are several references to instances where Coopers selected a specific number of items (used sampling techniques) to test. (a) Comment on the appropriateness of the samples tested (size, relevance, sampling methods) (5pts) 8. Regarding Inventory compilations, Coopers was able to prove that none of the compilations they had selected for extensive review had contained fraudulent entries. (a) In light of this, discuss the importance of audit documentation. (3pts) (b) Identify and briefly explain two other instances in the Phar-Mor Case where better audit documentation could have helped Coopers in their defense. (4pts) 8. Read the plaintiffs courtroom strategy. Explain why you think the plaintiff chose to make the argument that they did. (4pts) 9. How much blame, if any, would you place on the investors for having made those huge investments into Phar-Mor? Explain (3pts) 10. The defense (auditors') strategy was to argue that they were essentially victims of a fraud perpetrated by Phar-Mor management. In your opinion, how valid is this view and should the jury have considered this in their verdict? (3pts) 11. Suppose that Phar-Mor had attempted to sue Coopers for negligence. Do you believe that they would have been successful or not? Explain (3pts) 12. Of the 38 investors and creditors who filed suit against Coopers, only 8 took their cases to trial with the remainder settling out of court. Do you consider the out of court settlements to be an admission of guilt on the part of Coopers? Explain (3pts) 13. Do you agree with the Jury's verdict? Why or why not? (3pts) ----l i cAsE 4.6 Phor-Mor, lnc. Accounting Froud, Litigotior, 0nd Auditor Liobiliry Mam s. Bsaslnv' FnaxrA. Buc