JACK GREENBERG, INC.

Case 2.1 Jack Greenberg, Inc. 101 © 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 2.1

JACK GREENBERG, INC.

Synopsis In the mid-1980s, Emanuel and Fred Greenberg each inherited a 50 percent ownership interest in a successful wholesale business established and operated for decades by their father. Philadelphia- based Jack Greenberg, Inc., (JGI) sold food products, principally meat and cheese, to restaurants and other wholesale customers up and down the eastern seaboard. The company’s largest product line was imported meat products. Following their father’s death, Emanuel became JGI’s president, while Fred accepted the title of vice-president. In the latter role, Fred was responsible for all decisions regarding the company’s imported meat products. When JGI purchased these products, they were initially charged to a separate inventory account known as Prepaid Inventory, the company’s largest account. When these products were received weeks or months later, they were transferred to the Merchandise Inventory account.In 1986, the Greenberg brothers hired Steve Cohn, a former Coopers & Lybrand employee, to modernize their company’s archaic accounting system. Cohn successfully updated each segment of JGI’s accounting system with the exception of the module involving prepaid inventory. Despite repeated attempts by Cohn to convince Fred Greenberg to “computerize” the prepaid inventory accounting module, Fred resisted. In fact, Fred had reason to resist since he had been manipulating JGI’s periodic operating results for several years by overstating its prepaid inventory.From 1986 through 1994, Grant Thornton audited JGI’s annual financial statements, which were intended principally for the benefit of the company’s three banks. Grant Thornton, like Steve Cohn, failed to persuade Fred Greenberg to modernize the prepaid inventory accounting module. Finally, in 1994, when Fred refused to make certain changes in that module that were mandated by Grant Thornton, the accounting firm threatened to resign. Shortly thereafter, Fred’s fraudulent scheme was uncovered. Within six months, JGI was bankrupt and Grant Thornton was facing a series of allegations filed against it by the company’s bankruptcy trustee. Among these allegations were charges that the accounting firm had made numerous errors and oversights in auditing JGI’s Prepaid Inventory account.Contemporary Auditing 11th Edition Knapp Solutions Manual Visit TestBankDeal.com to get complete for all chapters

Case 2.1 Jack Greenberg, Inc. 102 © 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.Jack Greenberg, Inc.--Key Facts

• Emanuel and Fred Greenberg became equal partners in Jack Greenberg, Inc., (JGI) following

their father’s death; Emanuel became the company’s president, while Fred assumed the title of vice-president.

• JGI was a Philadelphia-based wholesaler of various food products whose largest product line

was imported meat products.

• Similar to many family-owned businesses, JGI had historically not placed a heavy emphasis on

internal control issues.

• In 1986, the Greenberg brothers hired Steve Cohn, a former Coopers & Lybrand auditor and

inventory specialist, to serve as JGI’s controller.

• Cohn implemented a wide range of improvements in JGI’s accounting and control systems;

these improvements included “computerizing” the company’s major accounting modules with the exception of prepaid inventory—Prepaid Inventory was JGI’s largest and most important account.

• Since before his father’s death, Fred Greenberg had been responsible for all purchasing,

accounting, control, and business decisions involving the company’s prepaid inventory.

• Fred stubbornly resisted Cohn’s repeated attempts to modernize the accounting and control

decisions for prepaid inventory.

• Fred refused to cooperate with Cohn because he had been manipulating JGI’s operating results

for years by systematically overstating the large Prepaid Inventory account.

• When Grant Thornton, JGI’s independent auditor, threatened to resign if Fred did not make

certain improvements in the prepaid inventory accounting module, Fred’s scheme was discovered.

• Grant Thornton was ultimately sued by JGI’s bankruptcy trustee; the trustee alleged that the

accounting firm had made critical mistakes in its annual audits of JGI, including relying almost exclusively on internally-prepared documents to corroborate the company’s prepaid inventory.

Case 2.1 Jack Greenberg, Inc. 103 © 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.Instructional Objectives

• To introduce students to the key audit objectives for inventory.
• To demonstrate the importance of auditors obtaining a thorough understanding of a client’s

accounting and internal control systems.

• To examine the competence of audit evidence yielded by internally-prepared versus externally-

prepared client documents.

• To identify audit risk issues common to family-owned businesses.
• To demonstrate the importance of auditors fully investigating suspicious circumstances they

discover in a client’s accounting and control systems and business environment.Suggestions for Use One of my most important objectives in teaching an auditing course, particularly an introductory auditing course, is to convey to students the critical importance of auditors maintaining a healthy degree of skepticism on every engagement. That trait or attribute should prompt auditors to thoroughly investigate and document suspicious circumstances that they encounter during an audit.In this case, the auditors were faced with a situation in which a client executive stubbornly refused to adopt much needed improvements in an accounting module that he controlled. In hindsight, most of us would view such a scenario as a “where there’s smoke, there’s likely fire” situation.Since the litigation in this case was resolved privately, the case does not have a clear-cut “outcome.” As a result, you might divide your students into teams to “litigate” the case themselves.Identify three groups of students: one set of students who will argue the point that the auditors in this case were guilty of some degree of malfeasance, another set of students who will act as the auditors’ defense counsel, and a third set of students (the remainder of your class?) who will serve as the “jury.” Suggested Solutions to Case Questions

• AS 1101.04, “Audit Risk,” of the PCAOB auditing standards defines audit risk as the “risk that

the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated, i.e., the financial statements are not presented fairly in conformity with the applicable financial reporting framework.” “Inherent risk,” “control risk,” and “detection” risk are the three individual components of audit risk, according to AS 1101. Following are brief descriptions of these

components that were also taken that standard:

•Inherent risk: refers to the susceptibility of an assertion to a misstatement, due to error or fraud, that could be material, individually or in combination with other misstatements, before consideration of any related controls.

Case 2.1 Jack Greenberg, Inc. 104 © 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.•Control risk: the risk that a misstatement due to error or fraud that could occur in an assertion and that could be material, individually or in combination with other misstatements, will not be prevented or detected on a timely basis by the company’s internal control. Control risk is a function of the effectiveness of the design and operation of internal control.•Detection risk: the risk that the procedures performed by the auditor will not detect a misstatement that exists and that could be material, individually or in combination with other misstatements.Detection risk is affected by (1) the effectiveness of the substantive procedures and (2) their application by the auditor, i.e., whether the procedures were performed with due professional care.According to the AICPA Professional Standards, the phrase “audit risk” refers to the likelihood that “the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated” (AU-C 200.14). “Inherent risk,” “control risk,” and “detection” risk are also the three individual components of audit risk within the AICPA Professional Standards. Following

are brief descriptions of these components that were taken from AU-C 200.14:

•Inherent risk: the susceptibility of an assertion about a class of transaction, account balance, or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.•Control risk: the risk that a misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal controls.•Detection risk: the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.(Note: Both AS 1101 and the AICPA Professional Standards point out that the product of inherent risk and control risk is commonly referred to as the “risk of material misstatement.) Listed next are some examples of audit risk factors that are not unique to family-owned businesses but likely common to them.

Inherent risk:

•I would suggest that family-owned businesses may be more inclined to petty infighting and other interpersonal “issues” than businesses overseen by professional management teams. Such conflict may cause family-owned businesses to be more susceptible to intentional financial statement misrepresentations.•The undeniable impact of nepotism on most family-owned businesses may result in key accounting and other positions being filled by individuals who do not have the requisite skills for those positions.•Many family-owned businesses are small and financially-strapped. Such businesses are more inclined to window-dress their financial statements to impress bankers, potential suppliers, and other third parties.