Audit Quality

Parmalat, the international dairy giant with 139 business units in 30 countries of more than 40 years history (Hamilton & Micklethwait, 2006) stepped on its way to meltdown due to its aggressive business strategy of worldwide expansion in the early 1990s. In order to cover the financial deficit caused by inefficient factories, poorly managed inventory and costly acquisitions in the long era expansion (Hamilton & Micklethwait, 2006) and to hide embezzlement to prop up failing family businesses, a constant infusion of cash is necessary.

However, cash could only be obtained if investments in Parmalat are seemed to be sound and attractive (Parmalat Case Study, 2009). Under this circumstance, Parmalat successfully used a number of offshore investment vehicles to create misleading transactions with the help of auditor Grant Thornton, financial institutions such as S&P and a series of banks.

The fraud was conducted in Parmalat through a series of action. Firstly, they created false and forged documents to create fictitious amount in the bank account. Then, they could over leverage the asset. After that, they pocketed the money obtained from the leverage in private. Meanwhile, they covered liabilities by using derivative financial instruments and complex financial transactions. (Parmalat Case Study, 2009)

Audit failure to ‘cash and cash equivalents’ Given the risk of cash manipulation, auditor should have focused more on two main types of assertions in relation to ‘cash and cash equivalents’ before issue an audit opinion.

One is about account balances. It requires GT-Italy to focus on both bank confirmation and tests of bank reconciliations (Gay and Simnett, 2010). Yet, GT-Italy did not undertake enough work and failed to fulfil its duty as a quality control device: it is believed that the account confirmation from Bank of America was created by Parmalat’s main office (Swartz, 2004). Whether GT-Italy has intention not to request for bank confirmation, or their requests was withheld by Parmalat’s managers does not change the fact that GT-Italy failed to fulfil their audit task.

Another emphasis should be put on assertions about classes of transactions and events pertaining to the account stated. To audit this type of assertions, GT-Italy should sight remittance advice and documents supporting payment, followed by focusing on transaction details, such as records of particular events that would have changed the cash amount (Gay and Simnett, 2010).

It is reported that Parmalat destroyed records of transactions after the scandal broke (Swartz, 2004). Hence, there was chances to obtain those records and uncovered the fraud when GT-Italy was performing the audit. But it seems that GT-Italy did not check such transaction details.

By failing to exercise reasonable care and skill, GT-Italy breached the duty of care to the public at large. Here, GT-Italy was guilty regardless the classification of fraud as ingenious or not. The problem should have been found or at least be suspicious as long as GT-Italy conducted a audit with necessary care and skill by collecting more persuasive evidences, for example, to trace back the records of transactions. Once the auditor has already thrown away his gun, it is useless to discuss how powerful his enemy is.

Fraud over casesUnfortunately, Parmalat is not the only failure with fraud issue around mass of corporate collapses. Parmalat has been dubbed “Europe’s Enron” (Executive Briefing, 2004) since “both revealed that misleading disclosure is a critical ploy in befuddling not only regulators, but also financiers and the investing public at large” (Clarke and Dean, 2007). In terms of fraud, they both used complex offshore structures, which involved mass of subsidiaries as well as carefully designed bonds and financial derivatives to make related transactions.

However, crucial differences could be identified, as the fraud in Parmalat was longstanding and breathtakingly crude with a whole new set of third party supports, whereas Enron’s fraud was more tricky and complex which mainly conducted by directors, “with an army of legal and financial advisers employed to build clever but devious structures that kept the company just inside the law” (Executive Briefing, 2004).

Another obvious feature of fraud at Parmalat is forging documents. When contrasting with the case Mckesson & Robbins in which forged documents had also been utilised, the purpose of Parmalat to falsify is to support the fake bank account while the other mainly focus on supporting fictitious inventories and account receivables.

Audit IndependenceAudit independence is closely related to the issue of audit failure (Callaghan, J. et.al., 2009). The business environment of Parmalat brings the issue of independence more particular. The professionals might be apt to argue that it is the provision in the Italian law, which mandates audit rotation for every nine years (O’Rourke, 2004) that help pick out such fraud at Parmalat.

The logic behind this legally mandated rule is that audit independence in appearance always serves as a virtue to an audit. It is true that Deloitte and Touche, after replacing the former auditor GT-Italy, was the first to scrutinise the fictitious amount of cash (O’Rourke, 2004).

But it is also true that it took Deloitte three years to uncover the fraud. Deloitte’s unfamiliarity with the company made it less efficient in doing the audit but more dependent on the work of other auditors. Before Deloitte could find sufficient evidence to challenge the opinion given, it had no choice but to accept it. The distinguished virtue that led Deloitte to uncover to problem is ‘independence of mind’, while the hurdle on the road to success is ‘independence in appearance’.

ConclusionSome may focus on how Parmalat case “has shown a long-term relationship can breed complacency” (O’Rourke, 2004), nevertheless our argument here is that what Parmalat really manifested is that being independent when forming a judgement is most critical. It is being compromised that is improper, but not being exposed to potential compromised (Clarke and Dean, 2007). Client intimacy does a great favour to the quality control device with an independent mind. The profession should concentrate on how client intimacy can work for an audit instead of nipping it in the bud.

References

* Callaghan, J. et.al., 2009, ‘Going Concern Audit Opinions and the Provision of Non Audit Services: Implications for Auditor Independence of Bankrupt Firms’. DOI 10.2210__91/17362

* Clarke, F. & Dean, G. 2007, ‘Independence: A Misplaced Quest for Honesty’ in Indecent Disclosure: Gilding the Corporate Lily, 1st ed., Cambridge University Press, Melbourne, 33-50.

* Clarke, F. & Dean, G. 2007, ‘Prologue: Gilding the Corporate Lily’ in Indecent Disclosure: Gilding the Corporate Lily, 1st ed., Cambridge University Press, Melbourne, 1-13.

* Executive Briefing 2004, ‘Italy food: Plenty of crying over spilt milk’ in Executive Briefing, 9 January.

* Gay, G. & Simnett, R. 2010, ‘Substantive tests of transactions and balances’ in Auditing & Assurance services in Australia, 4th ed., McGraw-Hill Australia, Sydney, 476-545.

* Hamilton, S. & Micklethwait A. 2006, ‘Parmalat: Milking the System’ in Greed and Corporate Failure: the Lessons from Recent Disasters, 1st ed., Palgrave Macmillan, New York, 153-172.

* O’Rourke, M. 2004, ‘Parmalat Scandal Highlights Fraud Concerns’ in Risk Management, 51(3), 44.

* Parmalat Case Study 2009, Parmalat Case Study 5, Documents for Small Business and Professionals, Retrieve: 3 October 2010, Available at: http://www.docstoc.com/docs/18662743/Parmalat-case-study-5

* Swartz, N. 2004, ‘Evidence of Destroyed Documents at Diary Giant’ in Information Management Journal, 38(2), 14.