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Please evaluate the facts in the case study and respond to the 5 questions on the last page. one question for one paragraphCendant Corporatlon lssessing the Control Environment and Evaluating Risk of Financial Statement Fraud IEARtIItIG OBJECTIUES ,”ltcr conrl)lcting ancl 1:cratir:ns ir.r nrorc than l00 countries inr,olving oier 30,000 er.nplovccs.Thc market value rrs. I 271, i :71. 1 l7+, 117;. 1276, I 172, )Ol+,1600 issrrcrl lx thr Sccrrritics antl l.rchirnqr'( orurui:sion- of Cenclant’s approximatelv 900 million shares of outstanding common stock at thc timc of the merger u’as estimatcd to be S29 billion, making it one of the 100 largest LL S. corporations. Senior managemcnt bclicr.erl that Ccnrlant, as.r global serlice provider, rvas uniquely positiclntr<1 to proviclc supcrior grorvth ancl value opportunitics f’rrr its ow’ners (Form 8-K, CUC International, Inc., Dccember 18, 1997). Initiallv, Ernst & Vrun$, LLP, CLICis auclitor, u,as retaincd to complete the auclit of CUC’s 1997 iinanciirl stalemcnts, irncl l)clo:itte ..Tiruchc’, LLB HFSh auditor, u’as rclained to complete the auclit of HFSis I 9c)7 financial statcmernts. Deloittc & Tiruche , LLP rvas selectccl as the successor auditor fllr the ut:r,llrr lormed (‘()mpan’. Cendant’.s ti-K filing *ith thc-‘securities arxl Exchange Comtnission announcing the sclection of I)t’lr>ittt .kTiruchc-,, LLP as thcr successor auditor noted that cluring thc past tu,o ycars there uerc no material usincss segments: trarel services, real estatt’ scrvic–es, and alliance marketing. The trarel services segment facilitatccl vacation timeshare exchanges, lnanages corporatc ancl govelnmcnt r,ehicle flects, and lranchises car rerntal and hotel businesses. Franchise *svstcnrs opcratcrl l>v Cc.ndant in this business sc:grnent includcd: Davs lnn, Ramada, Hor,vard Johnson, Supcr 8, 1-rar.r:loclgc,V’illagcr Lo<lgc, Knights Inn,Wingate Inn,Avis, and l{esort Condominiums lnternational, LLC. ‘Ihe real estatc serviccs segrnent assisted with emplolee relocation, providcs homebul’ers u,ith rn()r’tgaqes, ancl iranchises real estate hrokcrage offices. Franchise systcms c-rperated by Cenclant in this business scgnlcnt inch-rletl: Ccntun, 2 l, C.rldlvell Banker, and ERA. f)re origination, salc, antl sen,icrtr ol’ residential rn()rtgage loans u’c’re handlc’d bv thc conrpany thrs ancl clicnt relaticlnships. Cendarrtis alliancc markcting activities u’t-:re conductecl thror-rgh sul>sitalcrl approxinratetv S 300 million. C.LiCls management allegecllr, inflated carnings bv recc.rrding fictitious r:evcnues ancl rcducing expenses 1o rneethll Street analvsts’earnings expcctations. CUC managcrs simplv lookecl at the analvsts’earnings estimates anrl fir:titiouslv inrr-easecl rt-‘vt’nues and/cx’ rcrduccd cxpcnscs to mect those expectations. Meeting anal.sts’ expectations artificially inflated CUCis stock prices thereby providing it with more opportunitics to mcrge or acquire other companies in the future through stock issuances. The prc’tax operating earnings w’erc inflatr:d bv Sl76 million, 987 million, and $31 million lor the first three quarters of 1997,1996, and 1995, rcspcctivelr-‘. The rnisstatements reflected in CUC s quartcrly reports {ilecl u.ith tl’re Securities and Exchangc (lommission w-ere not recorded in the general ledger. Hou,ever, for l’ear-encl rcporting purposes, CUC madc various l,ear-encl adjustments to incr 1997, 1996, anerateiy and fi ctitiously manul’acturcd. MARKET REACilON TO THE FRAUD Prior to t]rc announccmcnt of the lrau<i, Cendant’s stock was trading at a 52-ueek high olapproximatel,v S42 per share. After the seconcl announcement that the fraud 4.as morc r’r,idesprcacl than initialiv bclicvccl, Ccnclantis stock clropped to a 52-r’r.eek lorv of approximatclJ’ $ 16 per share, a 62 percent drop, causinfl a total market value dcclinc of over $20 billion.The resulting drop in Cendant’s stock price squelchecl the companvis planned $3.1 billion cash arrd stock acquisition of American Bankers Insurancc.Additionalh; numL:rous clas.s action lavr.suits rvcrc filed against the companv and thc current and tbrmer company ol{icers and dircctors. C)n March 17,1999, Ccndant rcachcrl an agreelrent on onc class action Iarvsuit that resulted in a S J5 l million pre-tax chargc to the 1999 financial statemcnts and on Decernber J,1999, Cendant reached an agrccment on the principal class actior-r lawsuit tlrat rcsultcd in a $2.83 billion pretax charge to the 1999 financial statements. ASSIGNING BTAME Matrv qr”rcstions rt’rlain in the aliermath of the CUC fraud. Hou’ couid CLICis senior management and the board oltlirectors not bc arvare of tlre fraud?Where u,as CUC’s audit cornmittee? Hor,r. could Ernst &Young, LLP, not havc cletected the fraucl? Inflormation obtained cluring the fi’aucl investigation suggests that Cosmo Corigliano, CFO of CUC, clircctcd or ras arvare of several of the irregular financial reporting activities notcd during the inr.estigation. Evitlcncc also suggests that Anne Pember, the controllcr of CUC, r,r’ho reportccl dir-ectlv to C-origliano, directed indivicluals to carr, out sorre ol’the irreguiar financial reporting actir,itir’s notcd. Ail told, morc than tw’cntv CIU(I employees were in, COO ol CUC, fr:r’ cause, eliminating thc cornpany’.s obligation to fulfill his prevkrr”rsly negotiated sev€rrance package.Waltcr Forbes rvas allotvcd to rcceive a sercrancc package totaling 547.5 million sincc he ‘rvas not directlv linked to the fraud; hou.eveq Cendant attcr.npted to rt’corer thc severance paymentWalter Forbcs receir..cd. l-rrlrlirr .rn,l [rllih Nt’tron. ( ),. rolrt.r’ I99li. pp. i’, 44. In Januart’ I999, Cendant Corporation filed a lawsuit against Ernst & Young, LLP, f<rr allegedl.y violating prof’essional standards. No re-‘solution o1’this lau.suit has been rnade public. Ernst &Young, LLP clid settle the principal shareholder class action larvsuit fbr $ 3 3 5 million. Additionallv, investigations by thc Sccuritie s ancl Exchange Commission and the United States Attclrnev for the District of’New-Jersey found that CUC and its predecessors r,ere issuing h’auduientlv prcparcd financial reports beginning as early as l985.Trvo Ernst &bung, LLP partners inl’olr.ed rn’ith thc audit enga-qement cluring the traud periocl agrct:tl to suspct.tsions li’on’r practice belbre thc SEC rvith rights to reapph’in tbur years.t’ lnJanuar-v 2005, a fcdcral jury convicted Kirk Shelton on lbcleral conspiracv and fraud char-qes.7 Kirk Shelton ?s sentenced to i0 t,ears in prison and ordcred to pav S3.275 billion in restitution to Cendant.sThe fine corers settlements paid by Cendant fbr.shareholder class action lar,vsuits and S25 million in legal fees paid b-v Centlant fbr Sheltonls legaldef’ense.Af1nr trvo mistrials in October 2006, a lbderatjurv convictedWaltcrA. Forbcs orr f’ederal conspilacv and false statement chargcs.eWalter Forbes lvas sentenced to 12 years, scven months in prison and also r:rdered to pa-v $3.275 billion in restitution to Cendant.lo Cosmo Corigliano,Anne Pember, and Caslter Sabatino pleaded guilw to f’ederal conspiracv and I’raud charges. Cosmo Corigliano nas sentencecl to 6 months house arrc-st and 3 vears probation while Annc Pcn-rbcr ancl Caspcr Sabatino u,ere sentencecl to t1c) vears probation.rr J’hese three individua]s u.crc givcn rcduccd scntcnces as a result of cooperating r,i.ith authoritit-‘s related to the Iraucl invcstigation. Cosmo Corigliano agreed to pa-v civil penalties in excess of s t+ million ancl Anne Pember agreecl to pay cir.il penalties of g 100,000. REOUIRED [ll P..lfbssional aucliting standarcls indicate that an cntit,v’,s internal controls consist of five interrelated comllonents. (a) What responsibility does an auditor have related to each of these fir,e cr:tnPonents? (b) One componcnt of internal control is the enti$’s control environment.What I’actors should an auclitor consider lvhcn eraluating the control cn’r.ironment? (c)What red flags were present during the 1995 through 1997 audits of CUC that mav have suggested weakncsses in CUCI control environment? [2] Professional auditing standards recognize there is a possibility that managemcnt mav override internal controls. (a) Provide an example wfiere managemcnt override occurrcd in the Ccndant fraud. (b)What are the require<l auditor responses to further address the risk of management override of internal controls? [3] Prof’.rrional auditing standards outline the auditor’s consideration of matcrial misstatemcnts due to errors and fraud. (a) What responsibility does an auditor have to detect material misstatements due to errors and fraudi qbl What two main categories of liaud affbct financial reporting? (c) What types of f’actors shoulcl auclitors consirlcr when asscssing the likclihood ol material misstatcments due to fraud? (d) Which f’actors existed cluring the I 995 through 1997 audits of CUC that createcl an environrnent conducive lbr lraud? [4] S.,t “r.l misstatements u,-erc ic]entifiecl as a result of the fraud pcrpetrated b,v CUC management. (a) For cach misstatement iclentified, inclicate one management assertion that vuas vioiated. (b) For each misstatemcnt idcnti{icd, inclicate one audit proccdure thc auditor could have used to detcct the misstatement. [5] So,r” o[ the rnembers ol CUC’s financial management team rv-ere lbrmer auditors for Ernst &Young, LLP (a) Whv u.ould a company want to hire a mcmber ol its external audit team? (b) If the client has hirecl firrmer auclitors, hor,v miglrt this affect the independence of thr: existing external auditors? Secthr:lirlkllin-qrvcbsitr.:http;././urvslrrr,loj.go’.ru”a,,/,rj/prrss/lilrr/cL:nrl0l1)4-r.htn. 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