Cendant Corporation, a company that sold travel and health club memberships, was the subject of an intensive fraud investigation that culminated in 1998. The company's Web site revealed the following statements contained in a report given to the SEC.
● Irregular charges against merger reserves-Operating results at the former Cendant business units were artificially boosted by recording fictitious revenues through inappropriately reversing restructuring charges and liabilities to revenues. Many other irregularities were also generated by inappropriate use of these reserves.
● False coding of services sold to customers-Significant revenues from members purchasing long-term benefits were intentionally misclassified in accounting records as revenue from shorter-term products. The falsely recorded revenues generated higher levels of immediately recognized revenues and profits for Cendant.
● Delayed recognition of canceled memberships and chargebacks (a chargeback is a rejection by a credit-card-issuing bank of a charge to a member's credit card account)-In addition to overstating revenues, these delayed charges caused Cendant's cash and working capital accounts to be overstated.
● Quarterly recording of fictitious revenues-Large numbers of accounts receivable entries made in the first three quarters of the year were fabricated; they had no associated clients or customers and no associated sale of services. This practice also occurred in the prior two years.
The company also had other accounting errors. Approximately 6 to 9 cents per share of the total estimated restatement of earnings resulted from the elimination of these errors. These accounting errors include inappropriate useful lives for certain intangible assets, delayed recognition of insurance claims, and use of accounting policies that do not conform to the applicable financial reporting framework.
a. Identify audit procedures (and audit evidence gathered) that could have detected the misstatement of revenues and intangible assets. Be specific about each of the four irregularities identified.
b. How would the auditor's assessment of management integrity and management motivation have affected the nature, timing, and extent of audit procedures identified? Explain the role of professional skepticism in this context.