Kaleigh Rapp ACCT 4420 Take-Two Interactive Software, Inc. 1. Analyze Take-Two’s 1998-2000 financial data included in Exhibit 1. Compute the following financial ratios for each of those years: age of accounts receivable, age of inventory, gross profit percentage, profit margin percentage, return on assets, return on equity, current ratio, debt-to-equity ratio, and the quality-of-earnings ratio. What major ‘red flags’, if any, were present in take-two’s financial statements given these ratios? Explain. Age of Accounts Receivable: 1998 – ($49,139 x 365) ÷ $194,052 = 92.4 Days or 92 Days 1999 – ($107,799 x 365) ÷ $305,932 = 128.6 Days or 129 Days 2000 – ($134,877 x 365) ÷ $387,006 = 127.2 Days or 127 Days Age of Inventory: 1998 – (365 ÷ 7.43) = 49.1 Days or 49 Days 1999 – (365 ÷ 7.40) = 49.3 Days or 49 Days 2000 – (365 ÷ 8.61) = 42.4 Days or 42 Days Gross Profit Percentage: 1998 – ($46,496 ÷ $194,052) x 100 = 23.96% 1999 – ($90,810÷ $305,932) x 100 = 29.68% 2000 – ($139,210 ÷ $387,006) x 100 = 35.97% Profit Margin Percentage: 1998 – ($7,181 ÷ $194,052) x 100 = 3.7% 1999 – ($16,332 ÷ $305,932) x 100 = 5.33% 2000 – ($24,963 ÷ $387,006) x 100 = 6.45% Return on Assets: 1998 – ($7,181 ÷ $109,385) = .065 1999 – ($16,332 ÷ $231,712) =.071 2000 – ($24,963 ÷ $351,641) =.071 Return on Equity: 1998 – ($7,181 ÷ $11,935) = .60 1999 – ($16,332 ÷ $11,935) = 1.37 2000 – ($24,963 ÷ $11,935) = 2.09 Current Ratio: 1998 – ($95,302 ÷ $73,505) = 1.29 1999 – ($187,970 ÷ $146,531) = 1.28 2000 – ($214,908 ÷ $152,023) = 1.41 Debt-to-Equity Ratio: 1998 – ($73,820 ÷ $11,925) = 6.19 1999 – ($146,609 ÷ $11,925) = 12.29 2000 – ($164,639 ÷ $11,925) = 13.80 Quality-of-Earnings ratio: 1998 – ($8,022 ÷ $7,181) = 1.11 1999 – ($16,748 ÷ $16,332) = 1.03 2000 – ($55,259 ÷ $24,963) = 2.21 The term ‘red flags’ then refers to any indicators throughout the financial statements that would be detected. Within Take-Two’s financial statements there are many red flags that could be pointed out, including; - The negative cash flow from operations - Significant rise in accounts receivable in terms of sales - Rising debt, told by the increasing debt-to-equity ratio 2. Identify the primary audit objectives that auditors hope to accomplish by confirming a client’s yearend accounts receivable. Explain the difference between ‘positive’ and ‘negative’ confirmation requests and discuss the quality of audit evidence yielded by each. a. The first of the objectives that the auditors are trying to confirm is both the existence and completeness of the balance. Existence is simply confirming the balance of the debtor’s is accurately represented in the total on the financial statements. While completeness is confirming the transactions accuracy and the recording of the transaction. b. A second objective of the audit is to perform the year-end revenue cutoff test by addressing; time of occurrence and completeness. Time of occurrence consists of tracing and vouching the transactions and events that have recorded throughout the entity for the current fiscal year in question. Completeness in this case is showing that all the transactions were recorded in the proper accounting period. Positive vs negative confirmation: A positive confirmation is when the audit team sends a letter to the company in question and requests a bank document in return. This bank document will need to either confirm the amount in question or dispute the amount in question and why. This also involves more cost during the audit in the long run. A negative confirmation is also a document sent out by the audit team to the company in question to confirm or dispute the amount in question. Unlike the positive confirmation, no response is needed if there are no discrepancies with the amount. If there is an amount that is when a response is needed. This confirmation is generally used when the company being audited has strong internal controls. In the long run negative confirmation, although less costly and less involved, is always considered to be sub-par to positive confirmation. This is because there is always the non-respondent who fails to dispute an incorrect balance, therefore making more work in the long run. Positive confirmation is generally favored by the audit team because it gets as much evidence collected as possible and give them the best picture of the company. 3. Identify audit tests that may be used as alternative audit procedures when a response is not received for positive confirmation request. Compare and contrast the quality of audit evidence yielded by these procedures with that produced by audit confirmation procedures. Generally when a response is not received for positive confirmation the auditors need to take alternate routes to obtain the information and reduce audit risk as much as possible. These alternative procedures may vary in accordance with the type of accounts in question. In the above listed scenario of accounts receivable, another audit procedure could be proving out cash receipts. Which includes matching revenues and expenses within the periods, shipment documents and client documentation. In the opposite, account payable, evaluation may include evaluation of cash disbursements or other similar documentation. As far as quality of audit evidence goes, any evidence that is received as part of the confirmation process can be considered higher in quality as it is from an external source. In general positive confirmation provides a more reliable and accurate data pool. 5. Is it appropriate for audit forms to sharply discount their professional fees for developmental stage companies? Why or why not? What problems, if any, may this practice pose for audit firms? During the beginning stages of a company, most of all their resources are committed to keep the company afloat. In order to keep up with the competition audit firms will offer their services at substantial discounts to help them from going under. Although this process may be considered inappropriate, it also has been shown that lower audit fees means lower quality of audit services. These discounting techniques can result in many problems, such as; price wars, inferior service, and more complex regulatory authorities. 6. Do you believe that the relationship between Robert Fish and Ryan Brant was inappropriate? Explain. Yes, I believe this relationship could be considered inappropriate because of the previous ties they had to one another. Robert Fish, the partner with PWC, has previously served as Bryant’s business advisor since the start of the company. In addition, Fish claims a father-son relationship with Bryant and had routinely supervised the company audits. This situation would cause a great bias in financial statement reporting because the main business advisor is also supervising the audit process within the company. In the end this relationship should be considered both unethical and unlawful in auditing procedures. 7. This is a question that I have used as an essay question on many in-class exercises and, occasionally, on the final exam for my graduate auditing seminar. As you might expect, I don't focus much on the “yes” or “no” answers provided by students but instead analyze the overall quality of the logical reasoning that they provide to support their answers. This question is certainly pertinent to this case because of the wide-ranging criticism that Take-Two has garnered for its Grand Theft Auto game. One strategy that I hope my students apply in responding to this question is to examine the issue it raises from the standpoint of the following six ethical “principles” included in © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Case 2.3 Take-Two Interactive Software, Inc. 123 the AICPA Code of Professional Conduct: Responsibilities, The Public Interest, Integrity, Objectivity and Independence, Due Care, and Scope and Nature of Services. Those students who use this strategy typically focus the Integrity and/or Public Interest principles. on in such circumstances and the quality of the audit evidence provided is almost always deemed acceptable. 4. The following list of alleged and/or potential deficiencies in the 2000 PwC audit of Take-Two will be helpful in responding to this question: failing to properly respond to high audit risk areas identified during the planning phase of the engagement, failing to investigate why such a modest response rate was received from the positive confirmation requests, failing to determine that the one positive confirmation request received was invalid (see footnote 18), accepting as audit evidence for the unconfirmed receivables subsequent cash receipts that could not be traced to specific invoiced sales amounts, identifying and reviewing only a modest amount of subsequent cash receipts related to the unconfirmed accounts receivable, failing to track the sample of five sales returns to specific invoiced sales transactions or otherwise investigate the validity of those sales returns. Of course, more general, broad-brush allegations were included in the SEC enforcement release. The case notes, for example, that the SEC charged that Fish “failed to exercise due professional care and professional skepticism.” Following are definitions/descriptions that I have found very useful in helping students distinguish among the three key types of auditor misconduct. These definitions were taken from the following source: D.M. Guy, C.W. Alderman, and A.J. Winters, Auditing, Fifth Edition (San Diego: Dryden, 1999), 85-86. © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Case 2.3 Take-Two Interactive Software, Inc. 121 Negligence. "The failure of the CPA to perform or report on an engagement with the due professional care and competence of a prudent auditor." Example: An auditor fails to test a client's reconciliation of the general ledger controlling account for receivables to the subsidiary ledger for receivables and, as a result, fails to detect a material overstatement of the general ledger controlling account. Recklessness (a term typically used interchangeably with gross negligence and constructive fraud). "A serious occurrence of negligence tantamount to a flagrant or reckless departure from the standard of due care." Example: Evidence collected by an auditor suggests that a client's year-end inventory balance is materially overstated. Because the auditor is in a hurry to complete the engagement, he fails to investigate the potential inventory overstatement and instead simply accepts the account balance as reported by the client. Fraud. “Fraud differs from gross negligence [recklessness] in that the auditor does not merely lack reasonable support for belief but has both knowledge of the falsity and intent to deceive a client or third party." Example: An auditor accepts a bribe from a client executive to remain silent regarding material errors in the client's financial statements. We can certainly conclude that the PwC auditors were not fraudulent in this case because they were unaware of the client's indiscretions and there was no effort on their part to deceive third-party users of Take-Two's financial statements Regarding the question of whether the auditors were Fraud. “Fraud differs from gross negligence [recklessness) in that the auditor does not merely lack reasonable support for belief but has both knowledge of the falsity and intent to deceive a client or third party." Example: An auditor accepts a bribe from a client executive to remain silent regarding material errors in the client's financial statements. We can certainly conclude that the PwC auditors were not fraudulent in this case because they were unaware of the client's indiscretions and there was no effort on their part to deceive third-party users of Take-Two's financial statements. Regarding the question of whether the auditors were negligent or reckless, recognize that the SEC enforcement release that focused on that audit and, in particular, Robert Fish's role in that audit, did not characterize the mistakes made as negligent or reckless. (Note: The issue of whether or not given auditors were negligent or reckless is often the central issue in a civil lawsuit filed against those auditors but is typically not addressed directly within an SEC enforcement release.) However, the SEC's enforcement release did strongly criticize Fish's conduct. For example, the SEC charged that "he failed to exercise due professional care and professional skepticism, and failed to obtain sufficient competent evidential matter” (taken from quote in case). This summary statement suggests that Fish was at least negligent in auditing Take- Two given the above definition of “negligence.” Was Fish reckless? Since we don't have access to all of the pertinent information for this case, it is difficult to decide whether or not his misconduct rose to the level of recklessness. Consider having your students debate this issue. What I often do in this type of setting is to have one group of students take one side of such a debate and another group of students take the other side. After a lively give and take between the two competing camps, I then have a third set of students vote (anonymously) to choose the "winner.
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