The Equity Funding fraud was the first major financial reporting fraud. It was a fraud that people believed would change auditing forever. However, the profession has taken a while to learn the lessons from Equity Funding.

Required
a. The following describes some of the major mechanisms used in conducting the fraud. For each item listed, identify audit procedures or changes in the structure of accounting that would have prevented the failure on the part of the audit firm to detect the Equity Funding Fraud. Organize your answer as follows:
Scheme Used by Equity Funding Auditing Procedures or Changes Suggested
i. Incomplete computer file.
ii. Recording all the fictitious policies on the computer system, but omitting the first three digits.
iii. Making simple transactions complex. To record a simple transaction to recognize a policy reserve, the company made over 30 journal entries across the books of four different subsidiaries.
iv. The company had different auditors audit the subsidiaries than audited the parent company.
v. The company was the largest single client of the CPA firm, and was the dominant client for the office.
vi. Whenever the auditor would ask for documentation of insurance policies, the company would indicate they would “pull” all the policies from the company files and have them the next day.
b. Explain why auditors generally prefer to have clients “pull” supporting documents that have been identified for audit testing.
c. What would be the additional cost if the auditor insisted on having the documents produced within the same day?
d. Are there circumstances in which the auditor should insist the documents be presented during the same day they were selected by the auditor for testing? Explain.