CASE 2.3
TAKE-TWO INTERACTIVE SOFTWARE, INC.
Synopsis
Grand Theft Auto is the sixth best-selling video game “franchise” of all time and easily ranks
among the most controversial as well. The game’s “adult” content has resulted in caustic and
unrelenting criticism by prominent politicians, public service organizations, and major media outlets.
Despite that criticism, Grand Theft Auto has been hugely profitable for Take-Two Interactive
Software, Inc., its maker and distributor. Take-Two was founded in 1993 by 21-year-old Ryan
Brant, the son of a billionaire businessman.
Street analysts.
Take-Two’s longtime audit firm, PwC, was also caught up in the company’s financial reporting
scandal. One of many SEC enforcement releases issued regarding that scandal focused on the
alleged misconduct of Robert Fish, the PwC partner who had supervised the 1994 through 2001
Take-Two audits. In particular, the SEC criticized the audit tests applied to Take-Two’s domestic
receivables by Fish and his subordinates. In addition, the PwC auditors were chastised by the SEC
for their alleged failure to properly audit Take-Two’s reserve for sales returns.
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Take-Two Interactive Software, Inc.—Key Facts
1. In 1993, when he was only 21-years-old, Ryan Brant organized Take-Two Interactive Software,
a company that produced and distributed video games.
2. Robert Fish, a PwC audit partner, supervised the annual audits of Take-Two from 1994-2001;
3. While Take-Two was in a developmental stage, PwC sharply discounted the professional fees
that it charged the company.
5. A video game produced by a company acquired by Take-Two would become Grand Theft Auto,
one of the most controversial but best-selling video games of all time.
6. An SEC investigation revealed that Take-Two executives recorded a large volume of bogus
7. Take-Two would ultimately be required to restate its financial statements three times over a
8. The SEC issued an enforcement release that criticized PwC’s 2000 Take-Two audit; the
9. Fish identified “revenue recognition” and “accounts receivable reserves” as areas of “higher
11. PwC also failed to properly audit Take-Two’s reserve for sales returns, which may have
prevented the firm from discovering the bogus sales recorded by the company.
12. The SEC sanctioned Fish, Brant, and three other Take-Two executives; Brant resigned from
Take-Two during the SEC’s investigation of the company’s scheme to backdate its stock option
grants, a scheme that he had masterminded.
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Instructional Objectives
2. To examine the nature of, and key audit objectives associated with, accounts receivable
confirmation procedures and related “alternative audit procedures.”
Suggestions for Use
You might begin class coverage of this case by asking for a show of hands of those students
who have played one or more versions of Grand Theft Auto. If you have “age appropriate” college
students, you will likely find that most of your male students have played the game, while just a
smattering of your female students have experienced the game. After asking for the show of hands, I
typically single out individual students and ask them to comment on whether or not they believe the
game is morally objectionable. More often than not, I receive a reply similar to the following: “It’s
Although this case raises some interesting ethical issues that you could discuss in class, its
central focus is on a relatively “plain vanilla” topic, namely, the application of accounts receivable
confirmation procedures and related “alternative audit procedures.” I like to couple these topics
together with the issue of what type of auditor misconduct was evident on the part of the PwC
auditors (see case question #4). It is often difficult to convey to students the literal meaning or
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Suggested Solutions to Case Questions
1. Following are the requested financial ratios for Take-Two for the period 1998-2000. Notice that
the accounts receivable turnover and inventory turnover ratios are also provided.
Financial Ratios for Take–Two:
2000 1999 1998
Age of Accts Receivable* 114.4 93.6 80.4
Age of Inventory* 63.5 57.2 57.9
* In days
Accts Receivable Turnover 3.19 3.90 4.54
Inventory Turnover 5.75 6.38 6.30
Equations:
A/R Turnover: net sales / average accounts receivable
Age of A/R: 365 days / accounts receivable turnover
Inventory Turnover: cost of goods sold / average inventory
Age of Inventory: 365 days / inventory turnover
Discussion:
The most prominent red flag revealed by these ratios is the extremely poor “quality of earnings”
being produced by Take-Two over this three-year time frame. Investors want and expect a company
to have a quality of earnings ratio higher than 1.0. Simply from a mathematical standpoint, you
would expect a company to have a greater than 1.0 quality of earnings ratio because of noncash
expenses, principally depreciation expense. A large number of factors may collectively or
individually produce a negative quality of earnings ratio for a given company. One such factor is
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up” on the given company’s balance sheet in such circumstances and cause net income to be higher
than net operating cash flows. Notice that the negative quality of earnings ratios being experienced
over the time frame 1998-2000 was accompanied by a telltale slowdown in accounts receivable
turnover (which, in turn, caused Take-Two’s age of receivables to increase significantly).
2. “Existence” and “valuation” are the primary management assertions that auditors hope to
corroborate when confirming a client’s accounts receivable. Confirmation procedures are
particularly useful for supporting the existence assertion. A client’s customer may readily confirm
that a certain amount is owed to the client (existence assertion), however, whether that customer is
willing and/or able to pay the given amount (valuation assertion) is another issue.
The key difference between positive and negative confirmation requests is that the given third
party is asked to respond to a positive confirmation request whether or not the information to be
confirmed is accurate, while for a negative confirmation request the third party is asked to respond
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3. Paragraph 32 of AU Section 330, “The Confirmation Process,” of the PCAOB’s Interim
Standards identifies the following “alternative procedures” that may be applied by an auditor when a
positive confirmation request has failed to produce a response: “examination of subsequent cash
receipts (including matching such receipts with the actual items being paid), shipping documents, or
other client documentation.” Notice the parenthetical statement which is very relevant to the Take-
4. The following list of alleged and/or potential deficiencies in the 2000 PwC audit of Take-Two
will be helpful in responding to this question: failing to properly respond to high audit risk areas
identified during the planning phase of the engagement, failing to investigate why such a modest
response rate was received from the positive confirmation requests, failing to determine that the one
positive confirmation request received was invalid (see footnote 18), accepting as audit evidence for
the unconfirmed receivables subsequent cash receipts that could not be traced to specific invoiced
sales amounts, identifying and reviewing only a modest amount of subsequent cash receipts related
Negligence. “The failure of the CPA to perform or report on an engagement with the
due professional care and competence of a prudent auditor.” Example: An auditor
fails to test a client’s reconciliation of the general ledger controlling account for
receivables to the subsidiary ledger for receivables and, as a result, fails to detect a
material overstatement of the general ledger controlling account.
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We can certainly conclude that the PwC auditors were not fraudulent in this case because they
were unaware of the client’s indiscretions and there was no effort on their part to deceive third–party
users of Take-Two’s financial statements. With regard to the issue of whether the auditors were
negligent or reckless, recognize that the SEC enforcement release that focused on that audit and, in
particular, Robert Fish’s role in that audit, did not characterize the mistakes made as negligent or
reckless. (Note: The issue of whether or not given auditors were negligent or reckless is often the
central issue in a civil lawsuit filed against those auditors but is typically not addressed directly
within an SEC enforcement release.) However, the SEC’s enforcement release did strongly criticize
Fish’s conduct. For example, the SEC charged that “he failed to exercise due professional care and
professional skepticism, and failed to obtain sufficient competent evidential matter” (taken from
5. Professional auditing standards do not address this issue. Rule-making bodies in the auditing
discipline apparently believe that the level of audit fees to be charged on any given audit engagement
is an issue that will be properly resolved by the interplay of supply and demand forces in the audit
market. It has been alleged in the past that major audit firms attempted to expand their client bases
by discounting their fees. Case 1.7, “Lincoln Savings and Loan Association,” notes that Arthur
Young & Company expanded its client base by more than 100 clients in the mid-and late 1980s.
Although not mentioned in that case, many third parties assumed that one tactic used by Arthur
Young during that “marketing campaign” was “aggressive pricing” of their audit services.
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6. The central issue here is whether Robert Fish maintained his objectivity and independence while
supervising the Take-Two audits, given his close relationship with Ryan Brant. Article IV,
“Objectivity and Independence,” of the AICPA’s Code of Professional Conduct provides the
following overview of those two important and related traits that auditors should possess.
As the AICPA notes, objectivity, which is the underpinning of independence, is a “state of
mind.” Consequently, it is impossible for third parties to discern whether or not an auditor performs
a given audit objectively. On the other hand, a close relationship between an auditor and his or her
client may cause third parties to question the auditor’s independence. This latter possibility is
sufficient to undercut the credibility of the auditor regardless of whether or not he or she maintains
an objective mindset during the given engagement.
7. This is a question that I have used as an essay question on many in-class exercises and,
occasionally, on the final exam for my graduate auditing seminar. As you might expect, I don’t
focus much on the “yes” or “no” answers provided by students but instead analyze the overall