Problem: Bliss sold unregistered limited partnership interests, using misleading financial statements (non-GAAP revenue recognition, omitted costs) and failing to disclose risks (e.g., Nationwide’s weak cash flows, IRS disputes).
Inquire about management’s securities expertise to assess control environment competence.
Inspect board minutes for fund-raising authorization, ensuring compliance with securities laws.
Obtain attorney/underwriter opinions on registration requirements, verifying legal oversight.
Study offering documents to verify financial information accuracy (Presentation/Disclosure).
Perform extended procedures on Nationwide’s business success claims, such as vouching cash flows or reviewing contracts (Valuation, Completeness).
Inquire about SEC interactions to confirm pre-sale clearance (Presentation/Disclosure).
Finding: Auditors issued unmodified opinions despite misstatements, indicating failure to test offering documents or verify Nationwide’s representations.
Action: Misstatements suggest inadequate procedures or lack of skepticism. Auditors should have expanded substantive testing (e.g., third-party confirmations of Nationwide’s finances) and reported securities law violations, leading to restatements or qualified opinions.
Outcome: Auditors faced SEC sanctions and AICPA expulsion, highlighting the need for rigorous procedures and legal compliance checks.
Problem: Verity’s president created Veritas, a related-party entity, to “sell” $40 million of inventory, masking a secured loan with a repurchase obligation, misstating liabilities and ratios.
Inquire about senior officials’ integrity and accounting knowledge to assess control environment risks.
Inspect board minutes for transaction authorization, checking for hidden details (Completeness).
Perform analytical procedures to identify unusual sales (e.g., 40% inventory spike), triggering further investigation (Completeness).
Examine sales contract for terms and business purpose, inquiring with officials (Presentation/Disclosure).
Research Veritas’s corporate records at the secretary of state to uncover related-party ties (Valuation, Presentation/Disclosure).
Request Veritas’s financial statements to verify transaction substance (Existence/Occurrence).
Finding: Auditors identified related-party ties and elicited the president’s admission of debt concealment.
Action: The related-party nature and loan structure indicated a material misstatement. Financial statements were adjusted to reflect the debt (pro forma: $430M liabilities vs. $390M recorded), correcting ratios and disclosures.
Outcome: Effective procedures (analytics, contract review) and skeptical evaluation prevented misstatement, demonstrating the value of digging beyond surface documentation.
Problem: The Blues brothers manipulated mining claim valuations through complex exchanges, inflating assets from $40,000 to $58 million, supported by biased appraisals and undisclosed related-party transactions.
Investigate appraiser independence via references and interviews, ensuring valuation reliability (Valuation).
Inquire about transaction oversight to assess control weaknesses in shell companies (Completeness).
Analyze transaction trail (purchases, exchanges, mergers) to understand valuation basis (Valuation).
Research corporate records for Alta, Silver King, and Pacific Gold to identify owners (Presentation/Disclosure).
Examine loan applications for contradictory representations to banks (Existence/Occurrence).
Confirm claim ownership with the Department of Interior or county deeds (Existence/Occurrence).
Evaluate appraisal reports for geological data or market comparables, testing valuation assumptions (Valuation).
Finding: Inexperienced auditors failed to unravel exchanges, accepted flawed appraisals, and missed related-party ties, leading to a $37 million bank loss.
Action: Findings of unverified valuations and undisclosed relationships required expanded procedures (e.g., independent appraisals, deeper ownership inquiries). Misstatements warranted restatements to reflect true claim values ($40,000 vs. $58M).
Outcome: Poor evaluation underscored the need for expertise in complex transactions and skepticism toward management-provided evidence.
Problem: Disney overstated revenue forecasts for Treasure Planet, leading to a $74 million write-down due to unrealistic assumptions compared to actual performance ($16.7M vs. $140M cost).
Inquire about forecast preparation processes to verify documentation of assumptions (Valuation).
Test arithmetic accuracy of forecast calculations, reviewing mechanical controls (Valuation).
Review forecast documentation to distinguish reasonable expectations from hypothetical assumptions (e.g., 15M ticket sales) (Valuation).
Compare forecasts to historical accuracy across Disney’s films, assessing reliability (Valuation).
Analyze industry publications and critics’ reviews for early performance data (Completeness, Valuation).
Vouch actual revenues to company records and box-office reports post-release (Completeness).
Finding: Overoptimistic forecasts ignored unfavorable historical trends and competing film data, leading to a material impairment.
Action: Discrepancies between forecasts and actuals (e.g., $16.7M vs. $50M expected) indicated valuation errors. Auditors should have challenged assumptions, requiring adjustments to reflect realistic values before financial statements were issued.
Outcome: Late write-down highlighted the need for robust substantive testing of estimates and critical evaluation of management bias in creative industries.
Applying audit procedures in the finance and investment cycle involves tests of controls (e.g., inspecting approvals, inquiring about processes) and substantive procedures (e.g., confirmations, vouching, analytics) tailored to significant accounts (Investments, Long-Term Debt, Capital Stock). Evaluation of findings is critical:
Existence/Occurrence: Confirmations and document reviews detect fictitious or unauthorized transactions (e.g., Bliss’s partnerships, Alta’s claims).
Completeness: Analytics and third-party data ensure all transactions are recorded (e.g., Verity’s hidden debt, Disney’s revenues).
Valuation: Vouching values and testing assumptions address overstatements (e.g., Alta’s inflated claims, Disney’s forecasts).
Presentation/Disclosure: Contract reviews and inquiries uncover misclassifications or omissions (e.g., Verity’s loan, Bliss’s risks).
Adjustments: Material misstatements (e.g., Verity’s $40M debt) prompt restatements.
Expanded Procedures: Weak findings (e.g., Alta’s appraisals) necessitate deeper testing.
Reporting: Undetected errors (e.g., Bliss, Disney) may lead to qualified opinions or regulatory action.
These cases emphasize tailoring procedures to risks (complexity, fraud) and critically assessing evidence to ensure accurate financial reporting.