Audit Case 4 Discussion

Case 4.
3 Cendant Corporation
CENDANT CORPORATION
Case 4.3
Introduction
Cendant was organized three business parts: travel services, real estate services, and
alliance marketing. Management's and investor's high expectations and expected interactions
from the merger were quickly shrunk with the announcement of a massive financial reporting
fraud found in CUC's financials from 1995 through 1997. Cendant Corporation was formed after
the merger of CUC International in May 1997. CUC's management inflated earnings by recording
fictitious revenues and reducing expenses to meet expectations. The fraud overstated before tax
earnings by $262 million, $122 million, and $127 million for 1997, 1996, and 1995, respectively.
Prior to the announcement of the fraud, Cendant's stock was trading at $42 per share, which fast
dropped to $16 after the announcement. Throughout a nine year investigation and trial, CUC's
management, along with their external auditors, Ernst & Young, paid billions in restitution to
Cendant and investors. In addition, several key leaders of CUC received prison sentences and/or
-1-
Case 4.3 Cendant Corporation
1 (a)Auditor's responsibilities an internal auditor is expected to provide reasonable assurance for

risk, compliance with laws and regulations, as well as ensure that the financial statements do not
contain any material misstatements due to fraud or errors. Internal auditors perform tests on
accounts, procedures, and internal processes which help them provide their reasonable assurance.
The nature of audit evidence and the characteristics of fraud, the auditor is able to obtain
reasonable, but not absolute, assurance that material misstatements are detected. The auditor has
no responsibility to plan and perform the audit to obtain reasonable assurance that misstatement,
whether caused by errors or fraud, that are not material to the financial statements are detected.
2. The misstatements that arose from the fraudulent misstatements in the financial statements had
to do with hiding transactions, and information from the financial statements. Moreover, the
company falsified many accounting records and documents from the financial statements that they
presented. Furthermore, the generally accepted accounting principles standards were not
completely applied in terms of classifying material amounts as well as applying proper presentation
of financial statements. The audits of CUC that created an environment conducive for fraud included
misappropriation of assets which included misusing receipts, stealing assets, or causing an entity to
pay for goods or services that have not been received. Misappropriation of assets may be
accompanied by false records possibly created by dodging controls.
(c) Types of factors that auditor consider when assessing the likelihood of material misstatement
due to fraud:
i. Incentive/pressure to perpetrate fraud
ii. An opportunity to carry out the fraud
iii. attitude/rationalization to justify the fraudulent action.
iv. rationalizationto justify the fraudulent action.
v.
(d) The factors that existed from 1995 to 1997 audits of cuc that created an environment
encouraging for fraud
 Incentive/pressure: Management recorded fictitious revenues and reduced expenses to

meet analysts' earnings expectations which allowed them to inflate earnings. Moreover, the
controller of CUC Anne ember, forced members within the organization to perform irregular
activities.
 Rationalization: Many of the senior accounting and financial personnel participated in
irregular activities and personnel at many of the business units in their practices which they
believed were questionable
 Opportunity: Senior management failed to have in place appropriate controls and
procedures that might have enabled them to detect the irregularities in the absence of
actual knowledge of those irregularities (a)the Control Environment: The main responsibility
for the avoidance and discovery of fraud and error is with the governance and the
management of the entity. In the understanding of the control environment, the auditor
should consider the design and implementation of entity program sand controls to address
the risk of fraud. The absence such programs and controls could create a significant
deficiency or a material weakness
The Risk Assessment: The auditor should obtain sufficient knowledge of the entity's risk assessment
process tounderstand how management considers risks relevant to financial reporting objectives
anddecides about actions to report those risks. In evaluating the design and implementation of
theentity's risk assessment process, the auditor should consider how management identifiesbusiness
risks relevant to financial reporting, estimates the significance of the risks, assesses thelikelihood of
their occurrence, and decides upon actions to manage them. An entity's riskassessment process for
financial reporting that encompasses the elements of internal controlherein might be part of an
entity's risk management framework. As such, auditors should focuson aspects of the framework
that affect risks of material misstatements in financial reporting. Ifthe entity's risk assessment
process is appropriate to the circumstances, it assists the auditor inidentifying risks of material
misstatement.-Control ActivitiesThe auditor should obtain an understanding of those control
activities relevant to the audit.Control activities are the policies and procedures that help ensure
that management directivesare carried out;-Information and CommunicationThe auditor should
obtain an understanding of how IT affects control activities that are relevantto planning the audit.
Some entities and auditors may view the IT control activities in terms ofapplication controls and
general controls. Application controls apply to the processing ofindividual applications.Hence,
application controls relate to the use of IT to initiate, authorize,record, process, and report
transactions or other financial data. These controls help ensure thattransactions occurred, are
authorized, and are completely and accurately recorded andprocessed

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Case 4.

Case 4.3 Cendant Corporation

1 (a)Auditor's responsibilities an internal auditor is expected to provide reasonable assurance for

 Incentive/pressure: Management recorded fictitious revenues and reduced expenses to

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