Case Study “Something Went Sour at Parmalat”. Auditing

Louwers, T. J., Ramsay, R. J., Sinason, D. S., Strawser, J. R. & Thibodeau, J. C. (2015). Connect: Auditing & assurance services. New York: McGraw-Hill 6th Edition Binding: Non-Book. ISBN 0077632338 / 978-0077632335 The Project has no word limit. Nonetheless, your answers to the required questions are expected to be responsive and complete. All references and citations should be in APA format.
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Minor Project Individual CASE ASSIGNMENT
“Something Went Sour at Parmalat”
PROBLEM
There was much confusion when Italian dairy food giant Parmalat defaulted on a $187 million
bond payment in mid-November 2002. Default on a bond payment seemed difficult to believe
considering that a Parmalat subsidiary in the Cayman Islands had a $4.9 billion cash balance in
a Bank of America account. The problem was that the cash account did not exist.
Subsequent investigation revealed that, over a 15-year period, Parmalat’s management had
falsified accounts and created assets to hide losses of $10 billion from Parmalat’s Latin American
operations. Other allegations charged that Parmalat’s management had lied about repurchasing
$3.6 billion in bonds, which they had never done. By hiding losses and increasing assets on its
balance sheet, Parmalat was able to continue to borrow enough money from investors and
creditors to conceal and perpetuate the massive fraud.
AUDIT APPROACH
From 1990 to 1999, the Italian branch of Grant Thornton audited Parmalat. Under Italian law,
however, Parmalat was forced to change auditors periodically and chose the Italian branch
of Deloitte Touche Tohmatsu (Deloitte & Touche SpA) to be the company’s new auditor in
2000. Grant Thornton, however, continued to audit Parmalat’s offshore subsidiaries located in the
Cayman Islands.
Auditors first inquired about the Cayman Islands account in December 2002 and received a letter
on Bank of America letterhead in March 2003, confirming the existence of the account. The
letter, however, was a forgery, created in Parmalat’s headquarters. Nevertheless, the $4.9 billion
was listed on the subsidiary’s balance sheet as of December 31, 2002, and was consolidated into
Parmalat’s balance sheets dated December 31, 2002, and June 30, 2003.
The auditors missed several red flags. First, the size of the account, on its own, should have been
a red flag. It is very unusual for a large company to have so much cash in a single bank account.
In addition, between January 2000 and September 2003, Parmalat raised more than $5 billion in
debt offerings. With so much cash available in the Cayman Islands, why was Parmalat
continuing to borrow money?
Second, the communication received from the Bank of America was in the form of a facsimile
(see Parmalat Exhibit 1), which raises two issues. First, a fax transmission is not subject to the
same level of control as returning an original confirmation. Essentially, a fax can be sent from
almost anywhere and the originating phone number can be falsified by simply changing the
phone number in the transmitting fax machine. A mailed confirmation, however, passes through
the federal mail system and is postmarked with the originating zip code. Also, this particular fax
was smudged, raising more suspicions. Forgers routinely “age” their “originals” by repeatedly
photocopying them to obscure any telltale photocopying lines. Given these circumstances, the
auditors should have followed up directly with the bank.
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PARMALAT EXHIBIT 1
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Third, when such large balances represent a significant portion of a company’s balance sheet (in
this case, 38 percent of Parmalat’s assets were in the subsidiary’s bank account), auditors should
take additional care to obtain further corroboration. All told, the combination of a large bank
account and a questionable form of confirmation should have provided Deloitte & Touche SpA
sufficient warning to dig deeper.
DISCOVERY
Parmalat management also told Deloitte & Touche SpA that the company had a $617 million
investment in an open-ended mutual fund that it could access at any time. The company,
however, was unsuccessful in its attempts to retrieve the funds. Because no evidence was
available to support management’s claims, Deloitte & Touche SpA included a qualification in its
audit review report highlighting the lack of evidence and alerted regulators of suspicions of a
larger fraud.
Initial investigation revealed that massive amounts (estimates as high as $19 billion) of assets
were missing or nonexistent. Parmalat and its subsidiaries filed for bankruptcy protection in Italy
on December 27, 2003.
During the ongoing investigation, a Parmalat employee who had disobeyed orders to destroy
company documents turned over a number of incriminating computer disks to investigators.
With evidence mounting, Parmalat’s founder and CEO Calisto Tanzi admitted to prosecutors that
he was aware of the fraud. He also admitted to misappropriating Parmalat assets (more than $1
billion, prosecutors believe) to cover losses in other family-owned companies. It is unlikely that
investigators will ever know for certain what happened to the missing funds (whether they were
used to cover operating losses, pay creditors, or illegally enrich management). Twenty other
Parmalat executives, including members of Tanzi’s family, and the company’s former CFO,
former board members, and even lawyers, were indicted on charges including fraud,
embezzlement, false accounting, and misleading investors. On June 28, 2005, a judge accepted
plea bargains from 11 of those charged and sentenced them to prison ranging from 10 months to
2.5 years. In his January 2008 trial, Calisto Tanzi was found guilty of securities laws violations
and was sentenced to 10 years in prison for his role in the fraud. More than two years later, in
December 2010, Tanzi was also found guilty of fraudulent bankruptcy and criminal association
and sentenced to an additional 18 years in jail. After he unsuccessfully appealed that verdict in
2011, the court added another nine years to his sentence. He should be about 105 years old when
he is finally released.
REQUIRED QUESTIONS
1. What steps does an auditor ordinarily take when confirming cash balances held on deposits
with financial institutions?
2. What additional steps should the auditors have taken when they received the smudged fax
copy printed on Bank of America letterhead?
3. What red flags did the auditors miss?
4. What steps should Deloitte & Touche SpA have taken with respect to Grant Thornton’s audit
of the Cayman Island subsidiaries?
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