Case Study: Diamond Foods

Prepare a 2-3 page report (12 point type, double spaced) answering: -Requirement 2 (a)-Requirement 11 (a)-Requirement 12 (a)For Requirement 2, include citations/quotations from AS 2105 and AU-C 320 as a basis for your answer.For Requirement 12 (a), include citations/quotations from AS 2401 and AU-C 240 as a basis for your answer.

Diamond Foods, Inc.

Case Study

Requirement 2(a)

            The proposal for a junior auditor of Deloitte’s audit firm about immateriality of an adjustment of accounts payables of $20 million in comparison to the total liabilities violates PCAOB, 2018, AS 2105: Consideration of Materiality in Planning and Performing an Audit and AICPA, 2018, AU-C Sec 320 Materiality in Planning and Performing an Audit principles. According to PCAOB, 2018, AS 2105.07, “the auditor should evaluate whether, in light of the particular circumstances, there are certain accounts or disclosures for which there is a substantial likelihood that misstatements of lesser amounts than the materiality level established for the financial statements as a whole would influence the judgment of a reasonable investor.” Given that the Deloitte’s audit team has known about the agreement between Procter and Gamble and Diamond Foods, Inc. to acquire Pringles, the audit team should have paid closer attention to possible fraud which would make the financial indicators look more favorable and as a result, the stock price would rise. AICPA, 2018, AU-C para. 320 A5 provides a list of factors that may affect the identification of an appropriate benchmark in determining materiality. One of which states that an auditor should exercise professional judgment in the identification of an appropriate benchmark and use the element of the financial statement to “which the attention of the users of the particular entity's financial statements tends to be focused.” Therefore, the best benchmark in determining whether 20 million adjustments in accounts payable was material would be the profit of Diamond Foods, Inc., which brings $20 million adjustments to material 12.4% of 2010 Gross profit.

Requirement 11 (a)

The company has a lot of material weaknesses of an internal control system in fiscal 2011. The main weakness is “Tone at the Top”. Management of the company was openly involved in fraudulent transactions and purposely adjusted the financial statements which lead to material misrepresentations and false information to readers. Since the compensation of the management was tied to certain financial results, the management had the motivation to misrepresent information on financial statements. Having the anonymous line working would have prevented years of fraudulent misrepresentations of information.

The second material weakness of internal control system is lack of segregation of duty. As an employee stated, the CEO of the company made every decision and information was kept in a small circle, which is one of the signs of possible fraud.

Requirement 12 (a)

            According to PCAOB AS 2401.61, “the auditor should use professional judgment in determining the nature, timing, and extent of the testing of journal entries and other adjustments.” Given that the management has more power to penetrate fraud, the auditor should assess unusual tests, that the management is not aware of. In the given problem, the management did all alternations in respect of all audit tests were close to expectations. If the audit team had managed to run different tests all the time, that would increase the probability of catching the fraud. Moreover, Deloitte should have reassessed and increased the time for an audit of Diamond Food, Inc. According to the audit’ bills, Deloitte’s audit team had spent way too little time working on the audit of the company, comparing to the same-industry company (P&G). If the auditor identifies a misstatement, whether material or not, and the auditor has reason to believe that it is, or maybe, the result of fraud and that management (in particular, senior management) is involved, the auditor should reevaluate the assessment of the risks of material misstatement due to fraud and its resulting effect on the nature, timing, and extent of audit procedures to respond to the assessed risks. (AICPA, 2018, AU-C para 240.33) Therefore, when the management of the company could not clearly explain the nature of “continuity” payments, the auditor should have reassessed the timing of audit and make necessary accounts payable testing such as confirming accounts receivable balances through positive or blank confirmations, testing cut out sales, and inspecting correspondence with suppliers to obtain evidence whether the payments belonged to the period assured by the management of the company. The auditors failed to express professional skepticism as well as reassess the engagement to provide reasonable assurance whether the financial statements are free of material misstatements.