case week 2 amra

8/18/2019 Case Week 2 Amra

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cAsE

l

3

AMRE,

Inc.

In

the

popular movie

The Tin

Men released

in

1987, Richard

-reyfus

and Danny

DeVito

portray aluminum siding

salesmen

during

the early

1960s.

The two

com-

petitors

use

every

means

possible

to

obtain

an unfair

advantage

over

each other.

Like

other

aluminum

siding

salesmen,

the

key

to success

for

Dreyfus

and

DeVito

is

obtaining

and

vigorously

pursuing

"leads,"

or

indications

of

interest

from

potential

customeis.

Leadi

are

not only

a key

success

factor

for homb

siding

companies

but

also

figure

prominently in many

of these

firms

accounting

and

control

systems.

Take

the

caie

of

AMRE,

Inc., a

firm that

for

nearly

two decades

sold

home siding

and

interior

refurnishing

products

such

as

cabinet

countertops.

AMRE,

short

for American

Remodeling,

began

operations

in 1980

in

lrving,

Texas,

home

of the

Dallas

Cowboys.

Within

a

few

years,

the

fast-growing

firm

ranked

as the

largest

company

in

the

home

siding

industry,

an

industry

historically

dominated

by small

b,r,rsinesses

that.market

their

services

in one

metropolitan

area.

[n

1987,

AMRE

went

public

and

listed

its com-

mon

stock

on

the

New

York Stock

Exchange.

AMRE's

principal

operating

expenses were

advertising

costs

incurred to identify

potential

tlaas

via direct

mail

and

television

commercials.

Throughout

the

1980s,

AMRE

charged

a

portion

of

its advertising

costs

each

year

to

a

deferred

expense

account.

AMRE

justified

this

accounting

treatment

by maintaining

that

these

adver-

,irinn

-r,r

Uenefited

future

periods.

gain

accounting

period, AMRE

divided

its

total

uar,""r,iring

costs

by the nurnler

of

ners

leads

generatecl

that

perincl AI\4RE

tllen

rnul"

tipliecl

the'r'esuiting

"eost

pei'lead" by-

the

totai

nutrber

of

"unset

leads," that

is,

new

Ieads

that

had

not

yet been

pursued, to determine

the

amount

of

advertising

costs

to

a"f"r

in"

f,rm

charged,

ti-re iemaining

aclvertising

costs

fof t[1at

period

to its

advertis-

ing expeltse

account.

ln,rng

cr:eated

a

computer-based

"]ead

bank"

during

the

mid-]980s.

When

a

p,otential

customer

collacted ANIRE

a,-lerk

eollected

ancl

thert

etrtet'ecl

informa-

Iit,il irrtlre

lead

l,arik thJl

<

t,ultl

lrv

used

ru

develop

an

approptiale.sales

pitch

for

that individual. This information

included variables

such

as age,

income, home

market

value,

and

length

of

residency.

Data

for each sales

presentation were

also

entered in the

lead bank.

This

information

allorved

AMRE

to evaluate

each

sales-

person's

performance

by computing

measures

such

as

sales

as

a

percentage of

appointments,

cancellation

rate, and

average

dollar

sales

per

appointment'

The

cbntrol functions

and

data

provided by

AMRE's

computerized

lead

bank

contrib-

uted

significantly

to

the company's

eaily

success

in

the

intensel)'

co.Oatt,ive

home

Accounting for

"Leods"

Leqds

to

Trouble

When

AMRE went

public in Fe[ruary

1987.

lhe

company's

top

officers

gave

optimis-

tic

rerrenue

and

profit projections to

linancial

analysts

trackfng

the

firm.

(At

the

time,

AMRE's

fiscal

year ran

from

I\'lair

1

01

one

lrear

until

April 30

of

the next'

The

com-

pany'5

first fiscal

year as a

public

company,

fiscal

1988,

ended

April

30,

19BB)

As

the

end

of AMRE',s first

quarter

as

a

public compan]/

approached,

July

11,

1987,

the

net

income

projected for that

qual'ter ea

rliei in

the

Vear

rv:rs cleatly

unattainable-



SECTTON

ONE

Cotr{pneHei{sMr

C.qsEs

Robert

Levin,

an AMRE

executive and

major

stockholder, feared that

AMRE's

stock

price

would

drop sharply if

the company

failed

to

reach

its

forecasted

earnings

for

the first

quarter

of fiscal 1988.

Levin,

a

CPA

since

1972,

served

as

the

company's

principal

financial

officer

and

held the

titles

of executive vice-president,

treasurer,

and chief

operating officer.

To

inflate

AMRE's net

income

for the

first

quarter

of

fiscal

1988,

Levin instructed

the

company's

chief

accounting

officer,

Dennie

D.

Brown,

to

overstate the

number of unset

leads

in

AMREs

computerized

Iead bank.l

Brown,

in

turn, instructed

Walter

W. Richardson,

the

company's

vice-president

of

data

processing

who had

served as AMREs

controller

in

the

early 1980s,

to

enter

fictitious

unset leads

in

the

lead bank.

Entering

the

fictitious

leads in

the lead

bank

caused

a

disproportionate

amount

of AMREs

advertising costs for the first

quarter

of

1988

to

be deferred rather

than expensed.

This

accounting

scam

allowed

AMRE

to

overstate

its

pretax

income

for

that

quarter

by

approximately

$1

million,

or

by

nearly

50

percent.

Once

corporate

executives misrepresent

their firm's

operating results

for one

accounting

period,

the temptation

to manipulate

its operating results

in later

peri-

ods becomes

difficult to resist. ln the

second

quarter

of

fiscal

1988,

AMRE's

execu-

tives

again inflated

the

company's

unset

leads

to

understate

the

firm's

advertising

expenses.

During

the

third

and

fourth

quarters

of fiscal

1988, AMREs

actual

operating

results

again fell

far

short of expectations. At

this

point,

Levin

decided

to

expand

the

scope

of the

accounting

fraud. In

addition

to

overstating

unset leads,

Levin instructed

his

subordinates

to

overstate AMRE's

ending

inventory

for the

third and fourth

quarters

of

fiscal

1988. Richardson

complied

by entering

fictitious inventory in

AMRE's com-

puterized

inventory

records and

by

preparing

bogus inventory count sheets

that were

Iater

submitted to the company's Price

Waterhouse

auditors.

Ler

in also

instructed AMRE's

accounting

personnel

to

oveistate

the

company's

rev-

enue

for

the

third

and

fourth

quarters

of

Hscal

1988.

AMRE

used

the

percentage

ot

completion

method.

to recognize

re\/enue

on

unfinished installation

jobs

at the end

of

an

accounting

period.

To overstate the

revenue

booked on unfinished

projects

at

the

end

of fiscal

1988,

AMRE

grossly

overstated

their

percentage

of completion.

ln

fact,

AMRE

recognized

revenue at the

end of

fiscal

l9B8

on customer

projects

that

had

not

been

started.

AMRE

reported

a

pretax

income of

$12.2

million in its fiscal l9B8 financial

state-

ments.

A

subsequent investigation

by the Securities

and Exchange Commission

(SEC)

revealed

that AMRE's

actual

pretax

income

for

that

year

was

less

than

50

percent

of

the reported

figure. Before AMRE

fited its

1988

l0-K

with

the

SEC,

Levin

met

with

AMRE's

chief executive

officer and chairman

of

the board,

Steven

D.

Bedowitz.

At

this meeting,

Levin

admitted to Bedowitz forthe

first time that illicit accounting

meth-

ods had

been used

to overstate AMRE's reported profit

for

1988. According

to the

SEC's investigatioq

Bedowitz

"concurred

with

these efforts to improperly

increase

AMRE's

earnings."2

Bedowitz

and Levin

signed the

"Letter

to Shareholders"

included

in AMRE's

1988 annual

report.

That letter began with

the following

greeting:

"We

are

proud

1.

The information repolted in

this case rras

drawn principally

from

a

series

of enforcement

releases

issued

b5. the

Secrrrities and

Exchange

Commission

(SECt

in the

earlv

1990s. The individuals

involved

in

this

case

neither

admi.tted nor clenied

the

facts

as

represented

by the

SEC

2.

Secr-rrities and

Exchange

Commission.

-4ccounthg

and

Auditing Enforcement

Releose

No. 356,

I

l\iare h

[992.



CASE

I.3

AMRE,INc.

{.

F.

Nnr

ris.

Aj\lRE

Drarrinqshor

,Sellcrs.,,

Ttte

Neu,yotk

Times.lg

Dccernber

l9SB,

DB.

5.

lL,irt

ar(

to

announce

that

fiscar

rggg

was

another

record

year

for

AMRE

in

both

earnings

nd

revenues'"

In-

a

subsequent

AMRE

annual

report,

Levin

recatted

how

he

had

et

Bedowitz

in

r9gr,

severar

years

before

t

urin

a"clp;;;;

executive

position

ith

AMRE.

At

the

rime,

Levin

worked

for

a

buirdirg

il;il;ompany

that

was

an

MRE

supplier.

We

discouered

k

y

ue:?

uery

much

alife,

We

both

hod

a

lot

of

energy,

ombition,

nd

dreams.

aur partnership

wis

ineiitaOte.,

Price

waterhouse

issued

ar

unqualified

opinion

on

AMRE'S

financial

statements

for

iscal

1988.

Neverrheress,

a

financiar;r"rr"

tor

The

w"i

yii'n*rquestioned

the

redibititv

of

those

financiar

statements.iih"

"r;i;;oJri"J"r,

,hat

AMRE,s

use

of

he

percentage-of-compretion

accouniing

metrrooieemed

unrruur.

Businesses

typi_

ally

use

the

percentage-of-compretion

nietrroa

g.".rdJ"

r;;ue

on

projects

that

ake

severar

months,

if

not years,

to

.on,pi"tu.

AMRE''

i.*turrution;obs

required

onry

few

days

to

comprete.

Even

more

,rouiiing

to

the

analyst

was

the

three

weeks

of

unbiiled

revenue.s"lhat

AMRE

h"d

;.;;;i^a

on

unnnisnuJiirtuuution

jobs

nearhe end

of

r988.

That figure

ru"*"a

Lr.-.rsive

since

AMRi,;;;;..ge

time

ro

com-

lete

an

instailation

job

was

on"

*""t

.

it

e

analyst

arso

questioned

AMRE,j

adver_

ising

expense

fieure. r

irtriirg;;;;;"

.o,,pun1,;,

;;;;;;

adverrising

cosrs

ad

been

rising

rapidrv.

tn

rr*,iu.y,

,t*

"r"rvriili*;;ffi:#d

rhe

integrity

of

MRE's

fi

nancial

statements.

Tb

shorbse'ers,

it

rooks

rik-e

o

classic

p**l:

orrnrting

reoenues

and

understating

xpenses,

a

pattern

that

often

ends

in'o

,li*

,ri

ur."v,f"rr"nii"i,

ount

spokes-

ersonl

said

the

compony's

orrorrtirj

prartices

were

prop",

oniirr"

periodically

euieued

with

outside

auditors.s

'

--

-'

-

r'

vvv,

u,tu

&

AMRE's

1989 Fiscot

yeor

During

fiscar

l9gg,

AMRE's

executives

became

increasingry

concerned

that

their

ndisc'etions

woLrld

be

discovereO.

fn

,n"lf,ira

qrurt"r'oi;ir";;,

il

##j:

ors

decidecJ

to

end

the,account;rt

n-;;1'The

executives

met

regurarry

to

discuss

ow

best

to

tei:minate

the

fraud

*,rr"r,

i.irlng

the

suspicions

of

the

firm,s

Fr:ice

\/aterhorrspariditorsoncl

,rthe'pur,i"r

on"ier

rrocr

theexeculivessettledonwasto

t'ansfer'ficritious

assets

in

Aiil#i,j.i;oiing

.".o,os

ro

rhe

firms

Decks

division.

hat

division's

principar

line

of

urri""*

*"r

buirding

backyard

decks

on

residentiar

omes.

company

officiars

r,aa

ar.eaJy

a".ia"a

a"

"iirlrri"

in"

o."r,

division.

By

ransferring

approximately

$3

million

ot

n.titio*

assers

ro

ihr;;;;"r,

AMRE

,,bur-

ied"

the

write-offs

of

thos

utt",r

in'ir,"

iir.ontinu"a

operations

section

of

its

l9g9

ffi:T;'d;:enr.

AMRE

booked

,r,"ru,".i*offr,p;ir.i;"li;arrrg,,,"

third

quarter

company

executives

wrote

off

approximately

$5

million

of

additional

fictitious

ssers

as

losses

ot

expenses

in.

the

fourth

quarte-inr."iliig"g

#

ffi;;;;;;;.*

hese

write-offs

ancr

rho:"

gJ]ru

pr;;ilr

q;"rrer

resurred

in

^MRE

reporting

a

net

l""r.r^"j'::l,t

$6

milrion

for

1989.

Exhibii

t

iJ.*urirus

key

financiar

data

incruded

in

MRE's

1989

annual

repor.t

for

rhe

nu"_y"u.

f".iod

1985_19gg.



SECTION

oNE

CoI{pnrHsNsIVE

CASES

I

AMRE,

1989

1988

Year

Ended

Aprit

30,

1987

1986

1985

Contract

revenues

Contract

costs

Gross

profit

0perating

income

Net income

Working

capital

Totat

assets

Stockhotders'

equity

$183,885

64,702

179,78

7,602

(5,744\

11,779

50,399

27,774

$121,,033

41,,369

79,664

9,983

7,299

15,307

34,713-

23,565

{72,18V

25,017

47,77A

6,153

2,907

73,236

23,527

-16,895

$3e,575

$22,451

75,275

9,259

24,300

73,792

7,576

667

878

414

40

L75

7,239

2.477

7,334

456

;

The

Role

of AMRET

New

CFO

in

Terminoting

the

Accounting

Froud

In

March

I989,

near

the

end

of AMRE's

fourth

quarter

of fiscal

lg8g,

AMRE

hired

Mac

M. Martirossian

to

serve

as

the

company's

chief

accounting

officer.

Marti;;:;;,

;

cPA

since

1976,

had

more

than

I0

years

of

public

accounting

experience

with

the

Dallas

office

of Price

waterhouse,

which performed

AMRE'sinnual

audits.

In

July

1989,

Martirossian

assumed

the

titte

of

chief

financial

officer (cFo).

Levin,

who

hai

essentially

served

as AMRE's

CFO

for

several

years,

retained

the

titles

of

executive

vice-president,

treasurer,

and

chief

operating

officer.

while

becoming

acquainted

with

AMRE's

accounting

system

in

his

first

few

weeks

with

the

firm,

Martirossian

discovered

numerous

aciounting

entries

that

lacked

adequate

documentation.

Marti

rossian

immediately

began

inveiti

gatin g

this

obvious

inler,natr

conti:oi:

pi:oblerr.

No

croubt, A\,lRE s top

eNecuiiv.es

realizld

thit

the.inquisi-

tive

accountant

would

eventuall5.,

"put

two

and

two

together."

So,,

they

decided

to

reveal

the

frar:d

to

Martirossian.'(Recognize

thar biu

thls

pointlnl

uri*,r"";-rr;;

alreadl'

begun

terminating

the fr",idj

--o-"-"

The

startling

confession

made

bir

his

ner,r,

colleagues

stunned

N{artirossian.

On

April

28.

1989,

jusr

rwo

days

before

the

end

of fiscat t5g9,

Martirossian

calteJ

a meei-

irrg

r.r'ith

llrp

ereculires

invoh.ecl

in

llre

fraud.

Af

this meetirrq.

he insisted

tnut

in"

misstatements

remaining

in

the

companl,'s,accountingr".or;:

0"

fm;a[*fl,';;"

rected.

If

the

corrections

were

not

made,-Martirossian

Ihreatened

to resign.

Mortirossian

further stoted

that

he woutd

hotd'himself

responsible

for

the

company's

finonciol

statements

for

periods

after

fiscol

tggg, but

thrt

th"

scheme,s

participants

would

be responsible

for

correcting

the

misstatements

in the

periods

to which

rhey

related,

and for

oddressing

ony

questions

[from

AMRE's

independent

auditors

qnd

other

portiesJ

arising

from

the

corrections.G

Bedowitz

acquiesced

to Martirossian's

demands.

Initially.

the

two

men

decided

to

correct

AMREb

accounting

records

with

a

large

prior p"iioa

adiustrnent.

I;

;;;;

ter

of

days,

this

plan

backfired.

outside

direct,orson

etuna's

board

became

aware

of

the

prior

period

adjustment

and

began questioning

why it

was

necessary.

At

this

poinl,

AMRE's

executives,

including

Martirossian,

mei

to consider

other

alternatives

for

correcting

the

compan)"s

accounling

records.

The

executives

decided

that

the

6. Securities

and

Excheinge

Commission.

.AccoLrnting

ond.lu(liting

Enforcemcnt

Release

Na.

3g4.

30 Jr rrrp

1992.



cAsE

t.3

AMRE,

tNc.

cti ,

a

il

emaining

errors

in

AMRE''

accounting

records

wourd

be

written

off

against

the

:f,:,,:j:

::

ffJj::

:j

*;,?,:.'

q

u

a rtei

ir

ri,

cJr

iiig

"iutJeli,oa_",

o

i

n

g

ad

j

u

st

i

n

g

shortly

after

the

end

of

fiscal

1989,

Martirossian

attended

several

meetings

between

MRE'S

top

executives-and

repres"rr"ri"",

of

price

w"t

rh;;.

At

these

meetings,he

Iarge

accounring

adjustments

rn"J"

ry

g,fnE

au.infif,"i"rnn

quarrer

of

fisca[

9Bg

were

discussed:.

A""rrai"gi.

i;;

sEi,

u"ni.*"i"r"r"ior"rnr

rt

1e

orher

com_

ffYrrffilfves

provided

false

explanations

to

Price

waterhorr"."gu.airg

the

large

The

efforts

of

his

colleagues

to

mislead

the

price

waterhouse

auditors

troubred

artirossian'

Before

Price

fraterho"r".o.pr"t"a

itr

igs'9""rdiiri*nr,

Martirossian

rranged

a

confidential

meeting

at

a

local

hotelwr,r,

r,"y

p.i""

iaterhouse

personnel

ssigned

to

the

AMRE

audit.

Mirtirossian

t

aa

become

well

acquainted

with

several

f

these

individuars

during

rh"

r0

t;;;

he

worked

ro,

pii..iuterhouse,s

Daras

ffice.

At

this

meeting,

M:r:,,:?::,i,n

expressed

o

high

teoel

of

anxiery

regording

rhe

oudit,

nd

he

specificarv

stated

thot

o

pontiriii'ii

,iir'ri.Zri''ri,o"i*

,oss

the

smer.

est'"

Further,

he

orso

posed;r;t;;r;;;

,r,e.auditors

tnrt

tiin"f,ri)*ingry

unrerated

udit

issues

ond

euents

to

the

odjustmrir-ii

i,

,,

,o"^ii

i

iirzit-t-he

auaitors

to

the

ndisctosed

scheme

[occourtirj'iiiii;,'"

Although

he

hinted

strongly

to

the

auditors

that

AMRE,s

fourth-quarter

write_offs

ere

suspicious,

Martirossian

never

reveared

the

trueiaturl'o,

ouroor"

of

those

djusrments'

price

waterhouse.

urtimaterr

".""g,."g

1rr"

,"*j*nn_quarrer

adjust_

ents

before

issuins

an

unquarified

opinion

on

AMRE,s

19g9

financiar

statements.

o,owing

the

comprerion

or

the

rgag

"raii,

rvr;;;#r;;;;;i;

,

re*er

or

repre_

entations

add'essed

to

price

war"rrro,,s.-ihi-

r.u"r'i"a"i;;;r,,*;

he

a,cl

othcr

r<e,,

tulRE exec

uIir

.s

rr

t-r

e rru,

.;;,; ;

r""*r

Jgu

rarities

that

wourd

materialj_v

affect

the

ccuracy

of

Ihe

company.s

financiat

statements.

Durinq

fiscar

I990.

r\ia'tirossian

,^a"u""rr'r,

extensive

effort

to

improve

AMRE,s

ccounring

and

financiai

;;;;;';;''r,,.i,"r,

r;l';;;;;,

,;.i;;""cr

imprementing

eve'at

measrr-es

to

srrengrhe,

il;

;;;;;n,t

iri",rul';;;;;;l;rr,.m.

Marriros-

ian

atso

sear.crred

.re

csrnppn1,,,

o..o,,niin;,;;;;;;

;;,

:;i:',:-

'

,

ng

er.r.ors

a,de'ie*'ect

the

co,pan,'r

u..o*nii;;;;;;;r

ro

ensur.e

r'at

thel,were

being

prop_

rly

applied.

The

Froud

ls

Disclosed

publicly

In

1990,

the sEC'revealed^ that

jt

was

investigating

AMRE

s

financial

statements

for

the

revious

fewyears.

The

Nea

yorn

rime,

iiicre

in

late

rg8s

thil;ilenged

AMRE,'

inancial

data

prompted

that

investigu*irr-1"

"rly

lssi,;ffi'f".*"a

a

special

com-

ittee

consistinq

of

th'ee

outside

rr'"rrr""

"r

iti

board

,"

,.rr,irlr"

the

company,s

inancial

affairs.

Foilowing

il

"

.epoiioiir,o"io-*ittee,

AI\4RE

pubricry

r,eveared

that

rs

financiar

statemenrs

Iorreach

r,"rr

rggz

ihrJugh

rgg0,

bLrt

principaily

lgg'

and

Iggg,

ontained

mateiiar

errors.

err,lig

,".tutuJ-it.

financial

statements

for

each

of

thoseears

From

earr'

r992

th.oLrgh

mid-r994,

trre

igc

i*r"l

r"*rri;i";"r.rr

rereases

isclosing

the

.esults

of

its

ligtlrl,

irr,"riigriirn

of

AMRE,s

accounting

frauci.s

r.

ll,ttd

S

.\l\4RE

s

fi rr.rrrcili

.orrrlir

rurr

(.,,llt

jll

jerl

to,lelet

intate

rl

ceaseci

,perations

a ncr

fi rell

tor

in'oru.ta^.

ban

kr

rptc_'.,.

ltr.irrg

ri're

n

ricl-

l990s

tn

1997.

the

companr,



sEcItoN

oNE

CournnHeNsrw

CsEs

Each

of

the

AMRE

executives

who

actively

participated

in

the

fraud,

including

Bedowitz,

Levin,

Brown,

and

Richardson,

agreed

to

an

SEC

consent

order.

The

executives

neither

admitted

nor

denied

their

alleged

roles

in

the

fraud

but

pledged

not

to

violate

federal

securities

laws

in

the

future.

Levin

and

Brown

also

forfeited

proceeds they had

received from

the sale

of AMRE

stock

while

the

fraud

was

in

progr"r.. This

feature

of

the

agreement

required

Brown

to

pay

approximately

bfO,6OO

to the

federal

government.

Levin

paid

nearly

$1.8

million

to

tlte.fgdelal

q9v-

ernment,

including

a

$SOO,OOO

fine

for

violating

the

provisions of the

Insider

Trading

Sanctions

Act.

In November

1991,

The

Woll

Street

Journol

reported

that

Bedowitz,

Levin,

and

AMRE,

Inc.,

had

reached

an

agreement

to settle

a large

class

action

lawsuit

filed

by

AMRE

stockholders.e

This agreement

required

the

two

formerAMRE

executives

to

contribute

approximatelv $a.5

million

to

a

settlement

pool.

AMRE,

Inc.,

contributed

another

$5.9

million

to

that

Pool-

Martirossian

reached

an

agreement

with the

SEC

similar

to the

agreement

made

by

the

federal

agency

with

the

otherAMRE

executives.

However,

the

federal

agency

issued

"

r"purui"

enforcement

release

describing

Martirossian's

role

in

the

{raud.

The

SEC

criticized

Martirossian

for

not insisting

that

proper

measures

be

taken

to correct

AMRE's

accounting

records

and

for

not

disclosing

the

fraud

to

Price

Waterhouse.

Martirossian's

non-participation

in

the

originol

fraudutlent

Yl"^"

connot

iustify

his

rrctions

in turning

a

blind

eye

to

the

methods

utilized

by AMRE

to correct

the

material

misstotements

.-.

. Akhough

he expressed

concern

and

posed

questions to AMRE's

ouditors

in

on

attempt

to

i*pot"

the

existence

of,

the

scheme

t9

them,

Martirossian's

effort

to discharge

nL

auty to

make

accurate

and

complete

disclosure

n

Unr'1ay(i'

fott-s

tritts

ineffeetu.tt

enr

misleac[inq beeeuse he'fai[eel

to

prouide

the

auditors

al[

of

the

*i

nrii,

i o,

h e

p

o

ssessed.ro

SEC

lnvestigotes

Price

Woterhouse's

1988

ond

1989

AMRE

Audits

After

the

SEC

finished

dealingwith

AMRE's

executives,

the

fe_deral

agency-turned

it,

ii,*r,tiun

io

the

compn,,1,"i

ind"p"ndent

audit

firm,

Price.Water}'iouse.

nf

??_C

focused

on

the

conduct

of

two

members

o{

the

AMRE

audit

engagement

team,

Edward

J.

Smith

and

Joel

E. Reed.

Smith

served

as

AMRE's

audit

engagement

part-

ner,

while

Reed

was a

senior

audit

manager

assigned

to

the

AMRE

audits.

Among

the

SEC's

complaints

lodged

against

Price

Waterhouse

was

that

the

audit

firm

failJd

to

properly teit

,qURg's

deferred

advertising

expenses'

Recall that AMRE

computed

theadvertising

costs

to

be

deferred

for

a

given

accounting

period

by

multi"

plying

the

"cost

per

lead;

for

that

period

by the

number

of

"unset

leads"

at

the

end

of

ii

L

p""uioa.

One

method

AMRE

used

to inflate

its

reported

profits

was

to,create

ficti-

tious

unset

leads.

Staff

auditors

of

Price

Waterhouse

assigned

to

the

AMRE

en$a$e:

ment

verified

the

cost-per-lead

computation

during

the

lgBB

audit.

Howev:t-:rl".tPff

auditors

failed

to adequately

test

the

nurn-ber

of

unset

leads

reported

by

AMRE

at

the

end

of

fiscal

1988.

The

auditors

simply

compared

the

number

of

unset

leads

on

two

client-prepared

schedules.

9.

K. Blr,rmenthal,

',{N4RE,

Ex-Officem

Agree

to

Settlement

of

Stockholder

Lan'suit,"

The

ltall Street

,lournctl,l2

Novenrber

1991.

A13.

10.

SecuritiesanciExchangeConmission.-4c(-ountingrtncl

.AuditingErtfotcenentReleaseNo

394,

ll0.lLrne

1992



The

oudit

of

the

unset

reads

defenor

was

flaw,ed.because

no procedures

r.ere

Der_

ormed

to

uenrv

the

intesitv

ri;i;;;;;;

on

which

th";;;i;i;;;.

rn

ract,

the

reports

ere

not

supported

bv

undertyine,irn.

attniiin,ii:irii"iZlirrr",

teods

suppos_

illi" #';;;;E:; ,*#tr ;1,:;:, "';;;';a%"ir,,*";iii'iii,3t,ssaj,

,iilii,

Price

waterhouse's

audit

pranning

memorandum

for

the

Iggg

AMRE

audit

indi-

ated

that

EDp

audit

procedures

*oir,riu

used

to

test

the

integrity

of

AMRE,s

Iead

ank'

AMRE

executives

irrorra

inir,i"accotrnting

r'urJr""r"a

that

these

proce_

ures

wourd

resurt

in

aetectron

oi

rr"

il,iri"u.

ruuJl;*il;;;ank.

These

execu_

ives

persuaded

Smith

and

n*O

,.'nyp;r,

the

EDp

tests.

,

AMRE

arso

inflated

it'uportuJfio?iJ

u19""*airs

year-end

inventory.

During

iscar

1988,

AMRE's

inveyrrv

ir"*[.i

ov

zrs

p*"ri,"rir,i['rrL,n.ruured

68

per_

ent

and

inventory

purchases

in.r"ur"aio.

p";o;;.

i;;igiffinu

audit

plannino

emorandum

identified

the

rarge

increaruin

i*.nto.y

*

ui",

,il

factor.

The

audii

ranning

memorandum

ur* pJiri"a'"iiir,r,

an,,neiii

*ii'r;',

perpetuar

inven_

:H;n:i:#;l

n,,r

that

the

year-",Jinuun,o,y

;;;ffi

;;;,,,"0 o"

determined

by

Price

waterhouse's

initiar

audit

pran

for-r9gg

cared

for

the

observation

of

the

#:.;i;

j}Ij;:lTffi:[T,;::*i1,,"::1.11;a**',**uiou,y"uae.i.J

ma

n

ase

me

n

t

c

ompra

i

n

e

d

rr,

J,r*'

i,

".";g

:ffi

:

:,jH#:i,ililil;,,,Tii:;

:n*

bserved

bv

price

waterhouse

;";il;;;;.iar5z

increase;"";;or

rhe

1988

audir.

MRE's

executives

convinced

pri".wui"riouse

to

allow

AMRE

accounting

person_

el

to

monitor

the

physicur

.orro

uilr,rue.3f

t|_e^inventory

sites

that

the

auditors

ad

serected

for

observation.

a..o.oing',;,r,.

srct

rrr"riis"iiin,

onrou

manage-

ent

inflated

the

year-end

inventon,of

o"o"n

of

rhs

19

;r,,*"?r

ri"s

not

o6srr.i*l.Lt

"ear-end

bv

price

warerhouse.

irr"r"

i,,r."rrory

rir",

in.irJ;;',;"

rhree

sires

n,here

MRE

accounting

personn"r

our"rruo

ihelhysical

counts.

In

totar,

AMRE

overstatecr

ts^I988

year-end

inventory

by

$t.q

rnif

llon.'

During

the

third

and

fourr[

qru,

,",r

oinscar

r9gg,

AMRE

began

n,riring

off

irs

fi*i-

ious

assets.

Recail

rhat

AMRE's

"^".r,i,,"rl"nceared

,*"",

uii,iiirn

doilars

of

such

rire-offs

in

rhe

losses

booked

ro,

,n";,;,ir,*i

o".r,_

0,,,r,rllrn"

price

\\,arer.

o*se

aucriror,

,",,i",r.Jrh."L,-i;'i;#ri?i,r*,r*i,,

"-

"

;ffination

or

AMRE,s

ecks

division

during

nr."."l

r9S"S.

H;;;;

according

to

the

SEC,

rhe

price

Warer-

lff:;:::i:?,:,?:::?::"*.*:$','"1,i#i,,,n,

ro,

i,","

iu,*i*i,r,,ur

app,ying

while

writing

off

fictitiou,

urr"i,

Jrli"s'irr"

fourrh quarter

of

r9g9,

AMRE purged

7,000

bogus

unset

reads

r-,

,r,"

.r*priSrlr"a

r"rJ

ulri.

i;;rff;g"

cost

o[

these

eads

was

$r08.33.

meaning

that

the

i"rrLl.r,

rerared

to

tr,"iirriie_off

exceeded

1.8

million.

A

price

warerh"ouse,i"rr

"rila,

asked

an

AMRE

alcountanr

why

rhe

arge

nurnber

of

unser

readr

y;:;;i;;

1.""#o

from

the

read

bank.

.rhe

accounranresponded

that

the

unset

reads.h"a

u*,

irproperry

recorded

auu

a

an

.,accounting

control

weakness."

In

the

audit

,orr,pup"ri',r,"

,,.ri"rai,"].".".,r0"0,

based

on

he

AMRE

accountant's

statement,

tr,ut

ir,i,

i,weakness,,

was

an

,,isorated

incident,,

hat

did

nor

require

rurrher

irr"r,is.iil"

ii'iri,n

*Ji"";:;.r;ilo

,,,,,n

rhe

srarr

CASE

t.3

AMRE,

[vc.

jl

iTiiJ;:t

and

Exchange

Comrnission

Acr

ounting

ond

.Auditing

Enforcemerrr

Retcose

No

j54

12.

tbid.

)3.

tbid

.,at

-"9



SECTION

ONE

Co{,rpnsHsNslvs

CASES

auditor's

assessment

and

did

not require

any further

audit

procedures

to

be

applied

to

the large

adjustment.

The

SEC

also

questioned

Price

Waterhouse's

review

of the

quarterly

financial

data

included

in AMRE's

1989

10-K

registration

statement.

Near

the

end

of the 1989

audit,

Smith recommended

that

AMRE disclose

in the l0-K the

large

period-ending

1".oflJin-s

adiustments

that

were largely

responsible

for the

company's

net

loss

for

fiscal

1989.

AMRE's

executives

refused.

After

reconsidering

the

matter,

Smith

noted

in

the

audit

workpapers

that the

fourth quarter

adiustments

did

not

need

to

be

dis-

closed

separately.

Smith

concluded

thot

the

adiustments

did

not

requhe

disclosure

because

"the

quarterty

data

is

not

prt

of the finonciol

statements

and

the

disclosure is informatioe

only

- -- -

the magnitude

of

the adjustments

is not

sumcient

to

couse

us

to require

them

to

do it

[thot

is,

disclose

the

adjustmentsJ.aa

A

key

factor

that

reportedly

influenced smith and

Reed's

decisions

to

accept

AMRE's questionable

accounting

treatments

was their familiarity

with

Martirossian,

a

former

colleague

of theirs

in the

Dallas

office

of Price

Waterhouse.

According

to the

sEC,

smith

and

Reed

"relied

improperly

on

his

[Martirossian's]

unverified

repr"r"n-

tations

based

upon

their

prior

experience

with

him

and his reputation

for

integrity

within

Price

Waterhouse."r5

In

an

enforcement

release

issued

in

Aprii

1994,

the

SEC concluded

that

Smith

and

Reed

had

failed

to

comply

with

generally

accepted

auditing

standards

during

the

19BB

and

1989

AMRE

audits.

As

a result,

the

sEC

prohibited

Smith

and

Reed

irom

being

assigned

to

audits of

SEC registrants

for

nine months.

Questions

l.

Define

rhe

terms

ethics

and

professiorroLethrr^s.

Using the

following

scale,

er,aluate

the conduct

o[ eacl-r indir.iduaf

invoh,ed

in lhis

case,

-100.

.

Hiqhh,

Unetlrical

0........100

Highly

Ethical

,

Do

you

belier.'e

that

the individuals

who

behaved

unethicaily

in

this

case were

appropriately

punished?

Defend your

answer.

Identify

the

alternative

courses

of action

available

to Martirossian

when

he

became

aware

of

the accounting

fraud

at

AMRE.

Assume the

role

of

Martirossian.

Which

of

these

alternatirres

would

you

have

chosen?

Wh},?

was

AI\'trREi

practice

of

deferring

a por-tion

of its adi,ertising

costs

in

an

asset

account

appropriate?

Defend

you

unr*.r.

1.

11.

tbid

15.

Ibid



CASE

I.3

AMRE,IIc.

What

key

red

flags,

or

audit

risk

factors,

were

present

during

the 1988

and

1989

AMRE

audits?

Did Price

Waterhouse

appropriately

consider

these

factors in

planning

those audits?

Why

or why

not?

Was

Price

Waterhouse

justified

during

the

1988

audit

in agreeing

to

allow

client

personnel

to

observe

the

physical

counts at

certain

inventory

sites?

To

what

extent

should

an

audit

client

be

allowed

to

influence

key audit

planning

decisions?

sl^tlro.

3/,

"Evidential

Matter,"

identifies

five management

assertions

that

underlie

a

set

of

financial

statements-

Whieh of

theseassertions

should

have

been

of

most

concem

to Price

Waterhouse

regarding

the

large

period-ending

adiustments

AMRE

recorded

during

the

fourth

quarter

of

fiscal

1989?

What

responsibility

do auditors

have

for

quarterly

financial

information

reported

in

the

footnotes

to

a

client's

audited

financial statements?

7.

case week 2 amra

Documents