1 . What are several red flags that E&Y either was or should have been aware of in the audit of HealthSouth? Overall, there were three “red flags” E&Y was not aware of during the audit. First, they neglected the 500% net income increase from 1999-2001. This should have raised awareness because revenues only increased by 5% during that same period. Second, the internal auditors were denied access to some of the corporate ledgers. E&Y should have seen this as being one of the largest red flags. Third, the audit team failed to properly investigate employee complaints. 2.
What procedures can auditors perform to detect fraudulent entries made during the consolidation process? Most of the time, fraudulent activity is found by mistake. It is not the auditor’s responsibility to detect fraud, although they must assess internal procedures to establish if they are aligned with the company’s goals and needs. Preventative measures for detecting fraud during the consolidation process are applying ratios’ analyses, verification of a sample of transactions tracing unusual and unjustified entries close to year-end, interviewing management, and analyzing “beyond the umbers” through analytical procedures. . How can auditors determine a company’s true “tone at the top? ” Auditors could determine a company’s true “tone at the top” by performing, what some professionals would call, a “cultural audit. ” This would entail performing on-site observations of every level of management. Some questions that could be discussed are as follows: What is the degree of preoccupation with meeting analysts’ expectations within the organization? Are the shareholders’ and managers’ ideas and goals parallel?
An auditor could also gauge the fear and pressure associated with meeting numerical goals and targets. If there is fear within the workplace, then lower level employees are going to be easier to manipulate. Another important factor to investigate when determining a company’s ethical culture is the compensation and incentive plans for employees. These plans can alter an employee’s interpretation of right and wrong, thus causing fraudulent activity. 4. What is the appropriate response by auditors to information from “disgruntled” employees?
Depending on the severity of the fraud, the appropriate response can be different from firm to firm. A good way to detect fraud would be to listen to information disgruntled before the fraud occurred. The information will probably be false and misleading because the employee has held animosity for a while. Regardless, you should take the information seriously when it is first presented to you. 5. HealthSouth has sued E&Y, and E&Y is the target of a federal securities class action suit. What are E&Ys likely defenses against HealthSouth? Against the class action suit?
One of the main defenses E&Y took during the early stages of the HealthSouth suit was the fact that the SEC had no well-defined rules with regards to audit-related practices. Another defense was the mere fact that E&Y never faced a criminal indictment for the HealthSouth fraud. This was mainly due to the statute of limitations placed on securities fraud. It sets it at the earlier of (a) 2 years after the discovery of the facts constituting the violation or (2) 5 years after such violation. Thus, the DOJ was unable to file criminal charges against the firm because the artner on the audit (G.
Marcus Neas) was “unaware” of the fraud in 1993. 6. HealthSouth concealed the fraud by keeping the fraudulent transactions below $5,000. What recommendation would you have to E&Y to improve its sampling practices? Although many, small transactions are overlooked due to limits set by auditors, E&Y must examine their materiality limits in order to greater observe potential risks. Although many firms won’t go below a $5,000 limit, E could have benefited by possibly examining some of the lower amounts to see if there are any misstatements.