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.
Purchase answer to see full
attachment