Jack Greenberg Audit Case

JACK GREENBERG, INC. A. Synopsis

Jack Greenberg Inc. (JGI) is a wholesale meat company established by Mr. Jack Greenberg. The company situated in the eastern seaboard of United States offers a variety of meat, cheese, and other food products. Being a family – owned business, they did not value the importance of internal control. Soon after Mr. Jack Greenberg’s death, the company’s president, Emanuel, realized that they need to develop a more formal accounting and control system so they hired Steve Cohn as the company’s controller. He implemented new policies and procedures that will help in the company’s operations and accounting system. Fred, the vice president of the company, who used to be the one handling the prepaid inventory account, refused to cooperate with Cohn. Several processes were conducted before the merchandise would be considered passed from the inspections. The main focus of this case would be on the prepaid inventory account kept by the company. One risk that JGI faces is the “double counting” of inventories. It happens whenever there’s a delay in processing the delivery receipt forms. In the mid – 1980s, Fred began to intentionally overstate JGI’s prepaid inventory and he forced to reduce the products’ gross margins to compete with larger companies. He did these all just to make his ill father feel better. In addition, he mentioned that after his father’s death he kept doing the fraudulent act because of the “significant changes occurring in the market which adversely affected us.” Steve Cohn was given the title “Chief Financial Officer” (CFO) and he designed a computerized accounting system for the prepaid inventory in early 1992. Grant Thornton (GT) became JGI’s independent audit firm starting 1986 to 1994 and provided the company an “Engagement Compliance Checklist” several weeks before year – end. GT requested numerous documents from JGI such as those involved in the prepaid inventory account, Fred’s prepaid inventory log, and Cohn’s reconciliation report. Cohn passes documents thoroughly to GT except for the documents maintained by Fred. Because of that, GT received that information after the audit had already begun each year. In addition, GT auditors failed in discovering that much of the prepaid inventory was “double – counted.” During the audit of GT since 1992 to 1994, they gave several recommendations and comments about the company’s accounting and control system in their “Internal Control Structure Reportable Conditions and Advisory Comments” report. But still, Fred did not comply in those recommendations; until he was forced to submit falsified documents, which the GT auditors immediately detected. Fred was forced to admit that he did the fiddling of documents. JGI still retained GT to determine the impact of the fraudulent act and to develop a reliable set of financial statements. The Greenbergs provided this information to their company’s three banks. Within six months, JGI filed bankruptcy and ceased operations.

B. Case Facts  High sales prompted need for internal control so JGI hired Steve Cohn as controller. Segregation of duties is implemented. There were internal controls developed for many accounting functions but was unable to modernize control procedures over Prepaid Inventory account.  Suppliers required prepayment for meat items: 60% Prepaid Inventory and 40% Merchandise Inventory. Tracking inventory is not automated. Cohn developed controls and process to reduce risk of “double-counting” inventory. Fred, VP, refused to comply. Cohn eventually gave up his effort.  Fred intentionally misstated the inventory account. Key documents were destroyed and recreated.  Auditors investigated the Prepaid Inventory accounts and found unusual amounts of time between customs inspections and delivery to Greenberg warehouse. They followed up with questioning Fred regarding corroboration with the custom agents.  Auditors also wanted to match delivery receipts with 9540-1 forms. The forms were not organized and would have been too cumbersome to go through. Grant Thornton decided the forms were not necessary for the audit but wanted them for future audits.  The fraud was discovered by Grant Thornton in 1994.

C. Answers 1. Family owned business is a business where most of the shareholders are from the same family. Conflict of interest is possible in this kind of business. The auditor should observe the type of relationship among the family members. There should be a written agreement to specify rights, duties, and obligations for each member, the auditor should read those documents for further information. In this case, because of the conflict of interest and maybe, trust among each other, Emmanuel Greenberg did not force Jack Greenberg to follow Steve Cohn’s (their controller who later became the CFO) suggestion about changing the accounting system for the inventories which in the end, made Jack continue changing the numbers in the statements and manipulating the documents. The auditor should exercise more professional due care and be more competent by exerting more effort and diligence in this kind of business in order to discover fraud and misstatements. 2. For the prepaid inventories, the auditor should determine if they exist (all inventories in the record are existing and valid), if all prepaid inventories have been properly recorded in the records (completeness), if the value presented in the records is correct (valuation), and if the company really owns the prepaid inventories (rights and obligations). Misstatement of prepaid inventories by overstating it could lead to understatement of COGS which would lead to overstatement of Net Income. For the merchandise inventory, the auditor should also determine

the existence by physical counting the merchandise, completeness by tracing them to the records, and valuation by checking the schedule.

3. Externally prepared documents and evidence like confirmations, external statements and confirmations are more reliable than internally prepared documents like inquiry and internal statements. Internal documents may be already tampered with the management who seeks to defraud the users of their financial statements or they may hide facts which may make the auditor discover the irregularities, if any. The auditor should have relied less on the internal evidence and should have gathered more external evidence like confirmation from suppliers. 4. Performing walkthrough tests will frequently be the most effective way of achieving the objectives in discovering misstatements. An audit walk-through traces how a company authorizes, records, processes and reports a sample transaction to confirm that it's handled correctly. In performing a walkthrough, the auditor follows a transaction from origination through the company's processes, including information systems, until it is reflected in the company's financial records, using the same documents and information technology that company personnel use. Walkthrough procedures usually include a combination of inquiry, observation, inspection of relevant documentation, and re-performance of controls. In performing a walkthrough, at the points at which important processing procedures occur, the auditor questions the company's personnel about their understanding of what is required by the company's prescribed procedures and controls. These probing questions, combined with the other walkthrough procedures, allow the auditor to gain a sufficient understanding of the process and to be able to identify important points at which a necessary control is missing or not designed effectively. Additionally, probing questions that go beyond a narrow focus on the single transaction used as the basis for the walkthrough allow the auditor to gain an understanding of the different types of significant transactions handled by the process. It is required by GAAS. (Source: http://pcaobus.org/standards/auditing/pages/auditing_standard_5.aspx) 5. Aside from walkthrough tests, the auditor should have gathered more externally generated documents like confirmation from suppliers about the receiving date of the inventories so that they could vouch the documents to the records and determine the existence and completeness. The auditors should also have observed the physical count during the end of the fiscal year, so they can assure that the merchandise recorded is correct. They also should have matched the Form 9540-1 documents to the delivery reports when they discovered it rather than deciding that it’s not necessary for the audit. They should also have investigated more on the time lag between the date the meat arrived in the port and the time the meat arrived in the warehouse. Analytical procedures could also be done by comparing the prepaid inventory with sales, and comparing prepaid inventory during each year.

6. The audit firm has a responsibility of informing the client about their internal control weaknesses and suggesting solutions for these weaknesses. Cohn would not be able to insist these to the owners so the auditors should have insisted to change and improve the internal controls. After

which, they could have observed whether the company would follow their proposals and continue to do so.