In January 2005, a federal jury convicted Kirk Shelton on federal conspiracy and fraud charges. Kirk Shelton was sentenced to 10 years in prison and ordered to pay $3.275 billion in restitution to Cendant.' The fine covers settlements paid by Cendant for shareholder class action lawsuits and $25 million in legal fees paid by Cendant for Shelton's legal defense. After two mistrials in October 2006, a federal jury convicted Walter A. Forbes on federal conspiracy and false statement charges. Walter Forbes was sentenced to 12 years, seven months in prison and also ordered to pay $3.275 billion in restitution to Cendant. Cosmo Corigliano, Anne Pember, and C aseer Sabatino pleaded guilty to federal conspiracy and fraud charges. Cosmo Corigliano was sentenced to 6 months house arrest and 3 years probation while Anne Pember and Casper Sabatino were sentenced to two years probation." These three individuals were given reduced sentences as a result of cooperating with authorities related to the fraud investigation. Cosmo Corigliano agreed to pay civil penalties in excess of $14 million and Anne Fember agreed to pay civil penalties of $100,000.

REQUIRED

1. Professional standards outline the auditors consideration of material misstatements due to errors and fraud.

(a) What responsibility does an auditor have to detect material misstatements due to errors and fraud?

(b) What two main categories of fraud affect financial reporting?

(c) What types of factors should auditors consider when assessing the likelihood of material misstatements due to fraud?

(d) Which factors existed during the 1995 through 1997 audits of GUC that created an environment conducive for fraud?

2. Professional standards indicate that an entity's internal controls consist of five interrelated components.

(a) What responsibility does an auditor have related to each of these five components?

(b) One component of internal control is the entitys control environment. What factors should an auditor consider when evaluating the control environment?

(c) What red flags were present during the 1995 through 1997 audits of CUC that may have suggested weaknesses in CUC's control environment?

3. Professional standards recognize there is a possibility that management may override internal controls.

(a) Provide an example where management override occurred in the Cendant fraud.

(b) What are the required auditor responses to further address the risk of management override of internal controls?

4. Several misstatements were identified as a result of the fraud perpetrated by CUC management.

(a) For each misstatement identified, indicate one management assertion that was violated.

(b) For each misstatement identified, indicate one audit procedure the auditor could have used to detect the misstatement.

5. Some of the members of CUCs financial management team were former auditors for Ernst & , Young, LLP.

(a) Why would a company want to hire a member of its external audit team?

(b) If the client has hired former auditors, how might this affect the independence of the existing external auditors?