Kevin Hall and Rosemary Meyer (KPMG partner and manager, respectively) were investigated by the SEC for improper professional conduct on the U.S. Foodser vice (USF) audit.
Hall and Meyer found numerous examples showing that USF recognized revenue that it should not have. Although Hall and Meyer obtained and reviewed evidence documenting these improper transactions, they failed to act on the evidence.
In some cases, the transactions were identified as audit exceptions requiring adjustment in the working papers, but the exceptions were subsequently covered up with liquid whiteout.
Hall and Meyer ignored red flags in the audit evidence. According to the SEC complaint, they "improperly and repeatedly relied on management representations to confirm previous management representations, even though these statements were contradicted by objective evidence."
USF is the nation's second largest distributor of food to restaurants, schools, hospitals, and hotels. For the years under investigation, a significant portion of its income was based on inflated manufacturer rebates. The company ordered huge amounts of food from major manufacturers including Sara Lee Corp., Kraft Food Inc., Georgia-Pacific Corp., and Nestlé SA. These manufacturers agreed to pay USF rebates on the purchases that ranged from 8.5% to 46%.
According to accounting rules, rebates should be recorded as reductions in inventory cost when the company pays for inventory. USF recorded the rebate amounts before the inventory was paid for and greatly inflated the dollar amount of the rebates. This allowed executives to meet earnings targets and earn bonuses.
The amount of inventory ordered was much more than USF could sell. USF is owned by Ahold NV, a Dutch supermarket chain. Ahold is the world's third largest supermarket chain behind Walmart Stores, Inc. and Carrefour SA of France.
a. What financial statement assertion did USF violate? Explain how it violated this management assertion.
b. Suggest an internal control that would have been able to prevent or detect this misstatement. Describe how the control would work and how the auditor could test it.