Saint Thomas University

Module 2 Case Study 5

This case is about American Food Suppliers, Inc., and Barnacle. Barnacle acquired American

Food Suppliers, Inc. in 2000. The first two years after the acquisition, their external auditors

issued unqualified opinions, and in 2002 the audit was suspended due to a revenue recognition

fraud of $900 million.

1. What lesson can be learned from the American Food Suppliers case with regard to over reliance

on third party confirmations?

Third-Party confirmation is the process of obtaining and evaluating evidence from an

independent source. AICPA indicates that “that the reliability of audit evidence is influenced by

its source and nature and is dependent on the individual circumstances under which it is

obtained. 

 Audit evidence is more reliable when it is obtained from independent sources outside the

entity. 

 Audit evidence obtained directly by the auditor is more reliable than audit evidence

obtained indirectly or by inference. 

 Audit evidence is more reliable when it exists in documentary form, whether paper,

electronic, or other medium”

This case is an example of how the Third-Party confirmation can be manipulated, and over-

reliance on these confirmations can result in catastrophic. Auditors need to maintain a healthy

level of professional skepticism when dealing with third party confirmation and perform several

substantive testing in addition to vendor confirmation. The higher the risk of a particular
 financial statement assertion (vendor rebates), the more evidence the auditor should gather to

support the assertion

References:

External Confirmations. (n.d.). Retrieved March 21, 2020, from

[Link]

[Link]

2. What alternative substantive tests may have been available to the auditors of American Food

Suppliers? How do the alternate procedures differ from typical accounts receivable

confirmations when confirming vendor receivables?

The auditors could have used alternative tests, like requesting copies of agreements to vendors to

confirm rates. They could have exanimated subsequent events for cash receipts, require proof of

accounts payable to vendors, or other client documentation to provide evidence for the existence

assertion. Also, auditors should consider reviewing prior years’ information and see how the

account was in the past. Any of these processes could have detected the detail amount owned by

the vendors or at least a good sense of how much should be.

The risk of confirming accounts receivables differs from confirming vendor rebate receivables.

Therefore, alternate tests are essential in confirming vendor receivable. Confirmation for

receivables mainly look for existence and occurrences.

3. What mistakes were likely made by auditors of American Food Suppliers and what responsibility

does the auditor have to uncover fraud?

The over-reliance on the third party confirmation was a mistake. Even though these

confirmations are mostly viewed as reliable, the high volume of revenue within this vendor
 receivable should have raised a question on auditors, and further tests should have been

conducted. They should have compared similar audits information. Too much faith is not

acceptable; professional skepticism is a must and should have driven them to look deep and

consider other criteria.

4. The FASB has reduced the wide latitude that companies once had in accounting for vendor

rebates by issuing EITF Issue No. 02-16. What recommendations would you suggest to the

FASB for further improving the accounting and auditing guidance in the area of vendor rebates?

The EITF Issue No. 02-16 address the accounting for and the disclosure of vendor rebates. They

outline three different views:

I. a reduction in the cost of sales to the reseller

II. a reduction in some other expense, e.g., advertising; or

III. a type of revenue for the reseller

Additionally, the Task Force concurred that if the cash consideration is primarily an incentive for

the reseller to achieve certain sales levels, or to remain a customer of the vendor for a specified

period of time, then the consideration should reduce the reseller’s cost of sales. This reduction in

cost of sales should be systematic and rational, reflecting the underlying progress of earning the

incentive, assuming that the reseller’s progress is probable and reasonably estimable. If the

progress is not probable, or it cannot be reasonably estimated, the consideration should

reduce the reseller’s cost of sales as the relevant milestone is achieved (FASB, 2002).

My only suggestion for further improve the accounting and auditing guidance in the area of

vendor rebates, is creating a standard method of calculating these rebates when estimation is

done and requiring more than two verifications of these vendor’s rebate. Also, suggest
 companies classifying them in different sub-account of Cost of Goods Sold (COGS) when this is

the case. It is evident that deducting the COGS in just one period when the cash comes in, could

make the Income Statement to look unstable. Having a method of calculation or guidance on

how to do it could be helpful for companies and more accessible for Auditors to review. Also

having anything under COGS could give an auditor a hard time to find them. Tracking them in a

different sub-account under Cost of Goods Sold as Vendor Rebate could make them easy to

identify and verify.

References:

EITF 02-16 - [Link]. (n.d.). Retrieved March 21, 2020, from [Link]

[Link]

5. Define professional skepticism. Do you think that the auditors of American Food Suppliers

exercised enough professional skepticism? Why or why not?

Professional skepticism is an attitude all accountants and auditors must display when conducting

fieldwork. It is a foundation of the auditing profession that needs maintenance and updates to

evolve and support the audit of the future. “In the world of artificial intelligence, auditors will

need to understand and be skeptical about how the software is working and learning, as well as

understand why outputs from an artificial intelligence tool were possible, and interpret what they

mean in the context of individual and unique client situations” (Lord, 2018). This attitude

includes, questioning mind, being alert to conditions, requesting back up documentation and look

for accuracy in calculation. Put aside relationships with the entity and always look for the

possibility of misstatement due to error or fraud. In this case, auditors did not display sufficient
 professional skepticism, because they should have gone beyond the confirmation and make sure

those high revenues were authentic. Auditors should conduct specific tests, and question why so

high volume and how they were calculated. Contracts could have given them a better idea of the

rate, and confirming those agreements and accounts payable would had been essential.

References:

Lord, S. (2018, October 25). The enduring importance of professional skepticism. Retrieved

March 21, 2020, from [Link]

professional-skepticism-in-auditing

6. What is the difference between a financial statement audit and a forensic audit? When would

each type of audit be performed?

A forensic audit and financial statement audit are kind of similar in the careful examination of

financial records. What differentiates them is the intent and objective of the search, and they do

not overlap. Forensic audits require examining transactions and compiling information for use in

court cases. A financial audit assures the validity of a business' financial records, to provide

confidence in the financial report. "An auditor conducting a financial statement audit is charged

with performing audit procedures to discover financial statement fraud but not asset-theft fraud.

Forensic accounting is a specialized branch of accounting that requires training in fraud

detection. A forensic auditor examines a company's system of internal controls to identify any

weaknesses in the controls designed to safeguard assets and to determine whether anyone in the

company has exploited control weaknesses to misappropriate assets for personal gain" (Barnes,

2017).
A forensic audit may be performed to prosecute a party for fraud, embezzlement, or other

financial crimes. The auditor can serve as an expert witness during a trial. However, it is not

limited to that; forensic audits could also be involved in disputes related to bankruptcy filings,

business closures, and divorces. "Forensic audit investigations can uncover, or confirm, various

types of illegal activities. Usually, a forensic audit is chosen, instead of a regular audit, if there's

a chance that the evidence collected would be used in court" (Tardi, 2020).

A financial statement audit may be performed to add reliability to the reported financial position

and performance of a business and to check the effective operations of the organization. Also, to

ensure that the company complies with the regulations. This audit will give assurance in

management that the business is performing well, and it is prepared to meet challenges. Potential

investors and lenders will require audited financial statements before they will invest or lend.

References:

Barnes, D. (2017, November 21). Forensic Audit vs. Financial Audit. Retrieved March 21, 2020,

from [Link]

Tardi, C. (2020, February 5). A Forensic Audit Could Easily Detect a Padded Expense Report.

Retrieved March 21, 2020, from [Link]

Thomas, J. (2019, February 11). The Difference Between a Financial Statement Audit & a

Forensic Audit. Retrieved March 21, 2020, from [Link]

[Link]

7) Who acted unethically in this case? What were the consequences?

 Three former purchasing executives - $400k in civil penalties

probation

 Fifteen American Food Suppliers vendors

 Former CEO of American Food Suppliers - $10mil paid back to Barnacle

 Shareholders - US courts approved a $1.3 billion global class action settlement between

Barnacle and shareholders

 Employees that knew and did not do or say anything – Remorse and endanger their

reputation.

 Auditors that did not uncover the fraud – Jeopardize their reputation.

8) It appears that many people within American Food Suppliers knew of the fraud and either

helped perpetuate the fraud or at a minimum did not notify the auditors or regulatory agencies.

What options were available to the employees who knew about the fraud and wanted to do

something about it?

They could have reported the auditors or regulatory agencies; they could have sent an

anonymous letter if they did not want to get involved personally or if they were scared to lose

their job. They could have called a hotline and report the illegal behavior