John O’Connor and Irving Reilly were classmates at St.John’s. Both graduated in May, 1967 with degrees in Accounting. After serving in the Army, O’Connor joined the firm of Arthur Andersen, and Reilly joined Touche, Ross, Bailey & Smart after serving in the Coast Guard. In August, 1977, O’Connor and Reilly joined together and formed O’Connor & Reilly CPAs (O&R).

O’Connor and Reilly were very ambitious and focused and by 1987, O & R had achieved annual revenues exceeding $7.5 million and had employed over 30 people. This success encouraged O’Connor and Reilly to take steps to expand their geographical footprint and to become more aggressive in engaging in practice development activities. At the beginning of 2014, O & R had 42 partners, 525 professional staff and had 12 offices, all located in the Northeast, and the firm provided audit, tax and consulting services.

O & R had a large condominium complex as an audit client since 1996. Over the years, this complex had expanded very rapidly and in 2014 it was the largest and most exclusive condominium complex in New York City. Small studio apartments sell for an average price in excess of $1.5 million, and monthly maintenance fees on studios exceed $5,500. Four bedroom apartments sell for an average price of $14 million, and monthly maintenance fees on four bedrooms begin at $20,000. The complex is commonly known as the “place for New York’s Wealthiest.”

O & R’s annual fees on this client have grown steadily over the years, and in 2018 they exceeded $5.7 million, and they consisted of the following:

Audit Fees

- Condo complex

- 401k Plan for employees

Total Fees

Tax Services Bookkeeping Services

Total fees

$3,500,000 100,000 3,600,000

1,400,000 750,000 5,750,000

In 2017, the condo board hired Kathy Lindburger to start an internal audit function. The condo complex had grown so rapidly that its board felt that a best practice would be to have an

St. John’s University

The Peter J. Tobin College of Business

internal audit function. In 2018, the condo complex employed over 700 personnel and had revenues of over $400 million. Kathy is well suited for this position. She is a recently retired Deloitte and Touche audit partner who worked primarily in Deloitte's real estate practice. She was also the Professional Practice Director responsible for all technical matters and quality control for Deloitte’s northeast real estate practice.

After performing a risk analysis, Kathy prepared an audit plan which she presented to the condo board. After receiving approval for her audit plan from the condo board, Kathy immediately set out to execute her audit work. Kathy’s first project was to perform a review of the condo’s policies and procedures relating to disbursements. Upon encountering some difficulties in obtaining supporting documentation, Kathy expanded her procedures. As a result of her work, Kathy determined that there were unauthorized disbursements of approximately $100 million which were made over a ten year period of time. After confirming her conclusion, Kathy spoke with the chair of the condo board, Jason Mcintyre, the world renowned retailer.

After consulting with the condo board, Mr. Mcintyre retained noted attorney Chico Marx of the firm of Marx & Costello. After conferring with Lindburger and reviewing her documentation, Marx subpoenaed O & R’s work papers for the condo’s audits for the past seven years. He could not obtain the work papers for all of the years in which the problem existed as the work papers for the earliest years were destroyed in accordance with O & R’s record retention policy. In fact, O & R only had work papers for the past three years, and they could not offer an explanation as to why the prior year’s work papers were missing.

Marx retained Lori Zamboni, a nationally acclaimed forensic auditor to review the O & R work papers. Some of her findings are as follows:

● In each of the three years for which there were workpapers, O & R verified over 80% of the disbursements. However, the unauthorized disbursements in each of those years related to the portion which was not examined.

● O & R had not issued an engagement letter to the condo board in three years.

● ABC broker dealer has responsibility for custody of all the condo’s cash and

securities entrusted to it.

● A fraud meeting was “waived” in the last year by the O & R partner responsible

for the audit. He wrote a memo to the audit files documenting his conclusion that there was no additional fraud risk from those identified in the prior year audit and therefore a fraud brainstorming session was not required. The memo was also signed by the engagement manager and concurring review partner.

● Frank sinister, the CFO had the authority to purchase, receive, authorize disbursements and sign checks. This weakness was noted in the O & R audit work

Assignment:

St. John’s University

The Peter J. Tobin College of Business

papers, but there was no evidence that it was brought to the attention of the condo board.

Harvey Bizarre has been the audit partner on the account for the past seven years. Bizarre, who is very close to retirement, has been focusing less on his clients and directing most of his attention to transitioning to a retirement mode. For example, he purchased a beach house in South Hampton, and he has spent most of his time at this beach home. He directs work on his clients from the beach, and he reviews work by computer while sitting in his living room and watching MSNBC.

Messrs. O’Connor and Reilly are very concerned with these matters, and they had a meeting with Bizarre to assess the level of exposure that this matter presents. The following came out of the meeting:

● Bizarre indicated that the lack of separation of duties in the disbursement area was why the auditors chose a substantive approach and achieved a high level of coverage. Bizarre was quick to note that 80% coverage is the highest that he has ever achieved.

● Bizarre felt that the annual amounts of the unauthorized disbursements were not material. The condo complex is designed to break even. Over the last ten years, disbursements grew by an annual rate of approximately 10%. The unauthorized disbursements grew by a similar percentage.

● Bizarre indicated that he discussed the terms of the engagement with the condo board, and an annual engagement letter was not deemed necessary.

● Bizarre also indicated that in his judgement an annual brainstorming session was not required since nothing ever changed at the client.

- Discuss what procedures Kathy performed to uncover the unauthorized distributions.

- Prepare an audit program to illustrate the procedures.

- Discuss your views on whether O & R should be concerned or if the firm was justified under the auditing literature in how it conducted the audit. Support your conclusions with references to the appropriate auditing literature.