CASE 2.1
JACK GREENBERG, INC.
Synopsis
In the mid-1980s, Emanuel and Fred Greenberg each inherited a 50 percent ownership interest
in a successful wholesale business established and operated for decades by their father.
Philadelphia-based Jack Greenberg, Inc., (JGI) sold food products, principally meat and cheese, to
transferred to the Merchandise Inventory account.
In 1986, the Greenberg brothers hired Steve Cohn, a former Coopers & Lybrand employee, to
modernize their company’s archaic accounting system. Cohn successfully updated each segment of
JGI’s accounting system with the exception of the module involving prepaid inventory. Despite
repeated attempts by Cohn to convince Fred Greenberg to “computerize” the prepaid inventory
accounting module, Fred resisted. In fact, Fred had reason to resist since he had been manipulating
JGI’s periodic operating results for several years by overstating its prepaid inventory.
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Case 2.1 Jack Greenberg, Inc. 119
Jack Greenberg, Inc.—Key Facts
1. Emanuel and Fred Greenberg became equal partners in Jack Greenberg, Inc., (JGI) following
their father’s death; Emanuel became the company’s president, while Fred assumed the title of vice–
president.
3. Similar to many family-owned businesses, JGI had historically not placed a heavy emphasis on
internal control issues.
5. Cohn implemented a wide range of improvements in JGI’s accounting and control systems;
6. Since before his father’s death, Fred Greenberg had been responsible for all purchasing,
accounting, control, and business decisions involving the company’s prepaid inventory.
8. Fred refused to cooperate with Cohn because he had been manipulating JGI’s operating results
for years by systematically overstating the large Prepaid Inventory account.
10. Grant Thornton was ultimately sued by JGI’s bankruptcy trustee; the trustee alleged that the
accounting firm had made critical mistakes in its annual audits of JGI, including relying almost
exclusively on internally-prepared documents to corroborate the company’s prepaid inventory.
120 Case 2.1 Jack Greenberg, Inc.
Instructional Objectives
1. To introduce students to the key audit objectives for inventory.
3. To examine the competence of audit evidence yielded by internally-prepared versus externally-
prepared client documents.
Suggestions for Use
One of my most important objectives in teaching an auditing course, particularly an introductory
auditing course, is to convey to students the critical importance of auditors maintaining a healthy
degree of skepticism on every engagement. That trait or attribute should prompt auditors to
thoroughly investigate and document suspicious circumstances that they encounter during an audit.
In this case, the auditors were faced with a situation in which a client executive stubbornly refused to
Suggested Solutions to Case Questions
1. PCAOB Auditing Standard No. 8, “Audit Risk,” defines audit risk as the “risk that the auditor
expresses an inappropriate audit opinion when the financial statements are materially misstated, i.e.,
the financial statements are not presented fairly in conformity with the applicable financial reporting
Case 2.1 Jack Greenberg, Inc. 121
of the effectiveness of the design and operation of internal control.
•Detection risk: the risk that the procedures performed by the auditor will not detect a misstatement
that exists and that could be material, individually or in combination with other misstatements.
Detection risk is affected by (1) the effectiveness of the substantive procedures and (2) their
application by the auditor, i.e., whether the procedures were performed with due professional care.
•Inherent risk: the susceptibility of an assertion about a class of transaction, account balance, or
disclosure to a misstatement that could be material, either individually or when aggregated with
other misstatements, before consideration of any related controls.
•Control risk: the risk that a misstatement that could occur in an assertion about a class of
transaction, account balance, or disclosure and that could be material, either individually or when
(Note: Both PCAOB AS No. 8 and the AICPA Professional Standards point out that the product of
inherent risk and control risk is commonly referred to as the “risk of material misstatement.)
Listed next are some examples of audit risk factors that are not unique to family-owned
businesses but likely common to them.
Inherent risk:
•I would suggest that family-owned businesses may be more inclined to petty infighting and
other interpersonal “issues” than businesses overseen by professional management teams. Such
Control risk:
•The potential for “petty infighting” and other interpersonal problems within family-owned
businesses may result in their internal control policies and procedures being intentionally
subverted by malcontents.
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Detection risk:
•The relatively small size of many family-owned businesses likely requires them to bargain with
their auditors to obtain an annual audit at the lowest cost possible. Such bargaining may result in
auditors “cutting corners” to complete the audit.
How should auditors address these risk factors? Generally, by varying the nature, extent, and
timing of their audit tests. For example, if a client does not have sufficient segregation of key duties,
then the audit team will have to take this factor into consideration in planning the annual audit. In
the latter circumstance, one strategy would be to perform a “balance sheet” audit that places little
emphasis or reliance on the client’s internal controls. (Note: Modifying the nature, extent, and
timing of audit tests may not be a sufficient or proper response to the potential detection risk factors
identified above. Since each of those risk factors involves an auditor independence issue, the only
possible response to those factors may simply be asking the given client to retain another audit firm.)
2. The primary audit objectives for a client’s inventory are typically corroborating the “existence”
and “valuation” assertions (related to account balances). For the Prepaid Inventory account, Grant
Thornton’s primary audit objective likely centered on the existence assertion. That is, did the several
million dollars of inventory included in the year-balance of that account actually exist? Inextricably
Case 2.1 Jack Greenberg, Inc. 123
3. The controversial issue in this context is whether Grant Thornton was justified in relying on the
delivery receipts given the “segregation of duties” that existed between JGI’s receiving function and
accounting function for prepaid inventory. In one sense, Grant Thornton was correct in maintaining
that there was “segregation of duties” between the preparation of the delivery receipts and the
subsequent accounting treatment applied to those receipts. The warehouse manager prepared the
delivery receipts independently of Fred Greenberg, who then processed the delivery receipts for
accounting purposes. However, was this segregation of duties sufficient or “adequate”? In fact,
4. The phrase “walk–through audit test” refers to the selection of a small number of client
transactions and then tracking those transactions through the standard steps or procedures that the
client uses in processing such transactions. The primary purpose of these tests is to gain a better
understanding of a client’s accounting and control system for specific types of transactions.
5. As a point of information, I have found that students typically enjoy this type of exercise,
namely, identifying audit procedures that might have resulted in the discovery of a fraudulent
scheme. In fact, what students enjoy the most in this context is “shooting holes” in suggestions
made by their colleagues. “That wouldn’t have worked because . . .,” “That would have been too
costly,” or “How could you expect them to think of that?” are the types of statements that are often
124 Case 2.1 Jack Greenberg, Inc.
inventory accounting records to determine whether shipments of imported meat products were being
recorded on a timely basis in those records. For example, the auditors could have examined the
prepaid inventory log to determine when the given shipments were deleted from that record.
Likewise, the auditors could have tracked the shipments linked to the sample delivery receipts into
the relevant reclassification entry prepared by Steve Cohn (that transferred the given inventory items
from Prepaid Inventory to Merchandise Inventory) to determine if this entry had been made on a
timely basis. (Granted, the effectiveness of this audit test would likely have been undermined by
Fred’s fraudulent conduct.)
•During the observation of the physical inventory, the auditors might have been able to collect
identifying information for certain imported meat products and then, later in the audit, have traced
that information back to the prepaid inventory log to determine whether the given items had been
reclassified out of Prepaid Inventory on a timely basis. This procedure may have been particularly
feasible for certain seasonal and low volume products that JGI purchased for sale only during the
year-end holiday season.
6. An audit firm (of either an SEC registrant or another type of entity) does not have a
responsibility to “insist” that client management correct internal control deficiencies. However, the
failure of client executives to do so reflects poorly on their overall control consciousness, if not
integrity. Similar to what happened in this case, an audit firm may have to consider resigning from