Audit Knapp Answer

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CASE 8.1



Similar to most financial frauds, the Livent, Inc. fraud was masterminded by a few individuals, primarily Garth Drabinsky and Myron Gottlieb. However, numerous individuals were eventually drawn into Livent’s fraudulent schemes by its principal architects, including Maria Messina, the company’s chief financial officer (CFO). Messina, a former partner with Deloitte & Touche’s Canadian affiliate, had previously served as Livent’s audit engagement partner. The fraud unraveled following Livent’s takeover by an investment group led by Hollywood mogul Michael Ovitz. The new management team installed by Ovitz soon found that “massive, systematic irregularities” permeated the company’s accounting
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10. The “accounting manipulations” used by Livent officials included simply erasing expenses and liabilities from the company’s accounting records, improper deferrals of major production costs, and capitalizing common operating expenses.

11. In August 1998, Messina and four of her subordinates revealed the fraud to a Livent executive who had been appointed by Michael Ovitz.

12. In June 2001, a U.S. federal judge ruled that a class-action lawsuit filed against Deloitte for its failure to uncover the Livent fraud could proceed since there was a reasonable likelihood the audit firm had been reckless in auditing the company. Instructional Objectives

1. To emphasize the need for auditors to identify the key inherent risk factors posed by an audit client.

2. To illustrate the lengths to which client management will sometimes go to misrepresent its company’s operating results and financial position.

3. To examine the issues raised when independent auditors accept key accounting positions with former clients.

4. To illustrate the difficulty of uncovering sophisticated financial frauds masterminded by top client executives.

5. To emphasize the need for auditors to thoroughly investigate suspicious circumstances and transactions discovered during an audit engagement.

Suggestions for Use

In responding to Question #1, students are required to identify the
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