CASE 2.6
CBI HOLDING COMPANY, INC.
Synopsis
Ernst & Young audited the pharmaceutical wholesaler CBI Holding Company, Inc., in the early
1990s. In 1991, Robert Castello, CBI’s owner and chief executive, sold a 48% stake in his company
to TCW, an investment firm. The purchase agreement between Castello and TCW identified certain
“control–triggering” events. If one such event occurred, TCW had the right to take control of CBI.
In CBI’s fiscal 1992 and 1993, Castello orchestrated a fraudulent scheme that embellished the
company’s reported financial condition and operating results. The scheme resulted in Castello
receiving bonuses for 1992 and 1993 to which he was not entitled. A major feature of the fraud
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CBI Holding Company, Inc.—Key Facts
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2. The TCW-CBI agreement identified certain “control-triggering events;” if one of these events
occurred, TCW would take control of CBI.
4. A major feature of the fraud was the understatement of CBI’s year-end accounts payable.
6. Castello and his subordinates attempted to conceal the unrecorded liabilities by labeling the
payments of them early in each fiscal year as “advances” to the given vendors.
8. Because the auditors accepted the “advances” explanation provided to them by client personnel,
they failed to require CBI to record adjusting entries for millions of dollars of unrecorded liabilities
at the end of fiscal 1992 and 1993.
9. The federal judge who presided over the lawsuit triggered by Castello’s fraudulent scheme ruled
Instructional Objectives
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1. To illustrate methods that client management may use to understate accounts payable.
3. To illustrate the need for auditors to rigorously investigate questionable items discovered during
an audit.
Suggestions for Use
This case focuses on accounts payable and, consequently, is best suited for coverage during
classroom discussion of the audit tests appropriate for that account. Alternatively, the case could be
integrated with coverage of audit evidence issues. Finally, the case also raises several interesting
auditor independence issues.
As a point of information, you will find that this case doesn’t fully examine all facets of the
Suggested Solutions to Case Questions
1. “Completeness” is typically the management assertion of most concern to auditors when
investigating the material accuracy of a client’s accounts payable. Generally, clients have a much
stronger incentive to violate the completeness assertion for liability and expense accounts than the
other management assertions relevant to those accounts. Unfortunately for auditors, a client’s
financial controls for accounts payable are typically not as comprehensive or as sophisticated as the
Case 2.6 CBI Holding Company, Inc.
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2. Before answering the explicit question posed by this item, let me first address the “explanation”
matter. In most circumstances, auditors are required to use confirmation procedures in auditing a
client’s accounts receivable. Exceptions to this general rule are discussed in SAS No. 67 and include
cases in which the client’s accounts receivable are immaterial in amount and when the use of
confirmation procedures would likely be ineffective. On the other hand, confirmation procedures are
A final technical difference between accounts payable and accounts receivable confirmation
procedures is the nature of the confirmation document used in the two types of tests. A receivable
confirmation discloses the amount reportedly owed by the customer to the client, while a payable
confirmation typically does not provide an account balance but rather asks vendors to report the
amount owed to them by the client. Auditors use blank confirmation forms in an effort to identify
any unrecorded payables owed by the client.
Should the Ernst & Young auditors have applied an accounts payable confirmation procedure to
CBI’s payables? No doubt, doing so would have yielded additional evidence regarding the
completeness assertion and, in fact, likely have led to the discovery of Castello’s fraudulent scheme.
3. AU Section 561 discusses auditors’ responsibilities regarding the “subsequent discovery of facts”
existing at the date of an audit report. That section of the professional standards suggests that, as a
general rule, when an auditor discovers information that would have affected a previously issued
audit report, the auditor has a responsibility to take appropriate measures to ensure that the
130 Case 2.6 CBI Holding Company, Inc.
4. The key criterion in assigning auditors to audit engagements should be the personnel needs of
each specific engagement. Certainly, client management has the right to complain regarding the
assignment of a particular individual to an audit engagement if that complaint is predicated on the
5. Determining whether high-risk audit clients should be accepted is a matter of professional
judgment. Clearly, “economics” is the overriding issue for audit firms to consider in such
circumstances. An audit firm must weigh the economic benefits (audit fees and fees for ancillary
services, if any) against the potential economic costs (future litigation losses, harm to reputation,
etc.) in deciding whether to accept a high-risk client. Complicating this assessment is the fact that