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Group 4 Auditing

on 26 February 2014

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Former Businessman, Pastor & Convicted Felon
Conviction and Prison
Auditor Change

Tuesday, February 25, 2014
Barry Minkow
Going Public with ZZZZ Best

Bogus Insurance Restoration Contracts
Two business accounts closed
Customer Complaints
Bad checks
nagging vendors demanding payment
Barry Minkow was introduced to the carpet cleaning business at the age of 12.
At the age of 16 Minkow started ZZZZ Best in his parents garage.
ZZZZ Best Struggles
ZZZZ Best was only marginally profitable when first starting out and due to age and business, he was denied bank loans.

Minkow realized the major profitability in insurance restoration and focused his business on that. He saw the opportunity to dictate the size and profitability of his insurance restoration “business.”
Used his age and charm to become friends with wealthy business men and conned them out of millions right from the start of the company.
At the age of 20 he was CEO of a $300 million dollar company that cleaned carpets and furniture.

ZZZZ Best Commercial

Minkow's "the sky is the limit" philosophy drove him to be even more innovative

This move gave him access to bank accounts of investors nationwide.

This meant that he could no longer completely control his firms financial disclosures.
Registering with the SEC required auditors, investment bankers, and outside attorneys to peruse ZZZZ Best's periodic financial statements.

Ernst & Whinney retained for following year’s audit to enhance credibility of financial statements
Engagement Letter signed in September 1986 outlining 4 Services to be performed
Review of the company’s financial statements for the three month period ending July 31, 1986
Assistance in preparation of a registration statement to be filed with the SEC
Comfort Letter to be submitted to ZZZZ Best’s underwriters
A full-scope audit for the fiscal year ending April 30, 1987
Greenspan was never contacted by Ernst & Whinney to provide information he had previously gathered
Ernst & Whinney resigned June 2, 1987

Insurance Restoration Contracts accounted for 90% of ZZZZ Bests Profits

To convince Ernst & Whinney that the insurance restoration contracts were authentic, Minkow and his associate Tom Padgett generated fake insurance restoration contracts for ZZZZ Best.
Bogus insurance restoration Building
Preparation for the Site Visit:

Minkow sent 2 subordinates to Sacramento to find a large building under construction to use as a prop
They convinced the supervisor of the construction site to provide the keys to the building for a weekend
They placed placards on the walls indicating ZZZZ Best was the contractor
They paid the building’s security officer to greet the visitors

The collapse of ZZZZ Best

By February 1987, ZZZZ Best was trading at $18 a share, valuing the company at $280 million.

As rapidly as ZZZZ Best rose, it fell due to the credit card fraud of several years earlier.

The Times then wrote a story revealing that Minkow had run up $72,000 in fraudulent credit card charges in 1984 and 1985.

Ernst & Whinney discovered that Minkow had written several checks to support the validity of the nonexistent contracts.

ZZZZ Best's new board conducted an internal investigation that largely substantiated the fraud allegations.

Minkow and 10 other ZZZZ Best insiders were indicted by a Los Angeles federal grand jury in January 1988

On March 27, 1989, he was sentenced to 25 years in prison. He was also placed on five years probation and ordered to pay $26 million in restitution.
BY: Nakiah Smith, Jeffrey Magnus, Joseph Miller, Wasim Younes
1. Ernst & Whinney never issued an audit opinion on financial statements of ZZZZ Best but did issue a review report on the company’s quarterly statements for the three months ended July 31, 1986. How does a review differ from an audit, particularly in terms of the level of assurance implied by the auditor’s report?

One major difference between performing a review and an actual audit on the financial statements is that the review does not contemplate obtaining an understanding of internal control structure. A review does not assess control risk, tests of accounting records and responses to inquiries by obtaining corroborating evidence through inspection, observation or any other audit procedure. It can point out significant matters of the financial statements but does not provide assurance of their accuracy.
2. Professional auditing standards identify the principal “management assertions” that underlie a set of financial statements. The occurrence assertion was particularly critical for ZZZZ Best’s insurance restoration contracts. ZZZZ Best’s auditors obtained third‑party confirmations to support the contracts, reviewed available documentation, performed analytical procedures to evaluate the reasonableness of the revenues recorded on the contracts, and visited selected restoration sites. Comment on the limitations of the evidence that these procedures provide with regard to the management assertion of occurrence.

1) Insufficiency to support the occurrence
2) Rules implemented by the client
3) Consideration of the relationship between cost & usefulness

3. In testimony before Congress, George Greenspan reported that one means he used to audit the insurance restoration contracts was to verify that his client actually received payment on those jobs. How can such apparently reliable evidence lead an auditor to an improper conclusion?

The verification that the client was actually receiving payment on certain jobs was just simply providing Greenspan with the evidence about the assertion of the payments. However this method does not necessarily show the completeness and valuation of the payments. The client could have been receiving payments but they may have not been made in full, not on time, and in some cases the payments could not have been made at all. If this information was known this could have leadthe audit team to believe that something was not right and things were not as how Minkow did perceive them to be.

4. What is the purpose of predecessor–successor auditor communications? Which party, the predecessor or successor auditor, has the responsibility for initiating these communications? Briefly summarize the information that a successor auditor should obtain from the predecessor auditor.

Predecessor Auditor - did not complete an audit of financial statements and resigned

Successor Auditor - Considers to accept or has already accepted an engagement but has not been in communication with predecor

Communication between the predecessor and successor auditor is very important as it can yield important information as to whether or not the successor auditor should accept the engagement.

5. Did the confidentiality agreement that Minkow required Ernst & Whinney to sign improperly limit the scope of the ZZZZ Best audit? Why or why not? Discuss general circumstances under which confidentiality concerns on the part of a client may properly affect audit planning decisions. At what point do client imposed audit scope limitations affect the type of audit opinion issued?

-Yes the confidentiality agreement did improperly limit the scope of the audit.
-Under Auditing Standard 5, The auditor can express an opinion on the company’s internal control over financial reporting only if the auditor has been able to apply the procedures necessary in the circumstances.
-If there are restrictions on the scope of the engagement, the auditor should withdraw from the engagement or disclaim an opinion. A disclaimer of opinion states that the auditor does not express an opinion on the effectiveness of internal control over financial reporting

6. What procedures, if any, do professional standards require auditors to perform when reviewing a client’s pre-audit report but post-year-end earnings press release?

-There are no requirements in the professional standards that require auditors to perform when reviewing a clients pre-audit report but post-year-end earning press release.

- Although there are no requirements, companies usually let their auditors review the release before it is released to the press.
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