CASE 3.2
HOWARD STREET JEWELERS, INC.
Synopsis
A common nemesis of small businesses is employee theft. Small business owners who place too
much trust in their employees can suffer significant financial losses at the hands of apparently
hard-working and trustworthy employees. Such was the case for the husband and wife team who
owned the Howard Street Jewelers. For twenty years, the owners, Julius and Lore Levi, had worked
184
Case 3.2 Howard Street Jewelers, Inc.
185
Howard Street Jewelers, Inc.—Key Facts
1. Betty was a trusted and longtime employee of Howard Street Jewelers.
4. Julius Levi refused to seriously consider the possibility that Betty was embezzling funds.
5. Lore Levi subsequently informed the firm’s accountant that Betty might be stealing from the
Case 3.2 Howard Street Jewelers, Inc.
186
Instructional Objectives
1. To demonstrate to students that employee theft is an important internal control issue for small
businesses.
3. To demonstrate to students that a small business’s accountant often serves as a “control”
consultant for the business’s owners.
Suggestions for Use
The principal focus of this case is internal control, particularly internal control issues related to
small businesses. Consequently, this case is well suited to be discussed in connection with internal
control topics in an auditing or other accounting course. I use this case to reinforce the fact that even
Suggested Solutions to Case Questions
1. The Levis overlooked several important internal control concepts. First, one of the most
important control procedures within an organization is the segregation of key functional
responsibilities or duties. Three types of duties, authorization, recordkeeping, and custodianship,
should be segregated within each transaction cycle of a business if at all possible. The Levis allowed
2. a. AU Section 110 of the PCAOB’s Interim Standards summarizes an auditor’s responsibility
Case 3.2 Howard Street Jewelers, Inc.
187
for fraud detection. “The auditor has a responsibility to plan and perform the audit to obtain
AU Section 316 and AU-C Section 240 require auditors to complete the following general tasks to
satisfy their fraud detection responsibility:
1. Discuss [among members of the audit engagement team] the risks of material misstatement
due to fraud that are posed by a client.
2. Obtain the information needed to identify the risks of material misstatement due to fraud.
3. Identify the risks that may result in a material misstatement due to fraud.
Because fraud is often well concealed, auditors do not have an absolute responsibility to discover
fraud-related misstatements in a client’s financial statements, as explicitly noted in AU Section 316:
“However, absolute assurance is not attainable and thus even a properly planned and performed
audit may not detect a material misstatement resulting from fraud” (paragraph 12). For instance, in
cases in which forgery and/or collusion among client personnel has occurred, the likelihood that the
auditor will uncover the fraud is probably quite low regardless of the nature and extent of the audit
procedures employed. Conversely, an auditor’s responsibility to detect an obvious fraud, such as the
theft of huge amounts of inventory or the kiting of large checks at year-end, is much greater.
b. A review of a company’s financial statements requires the accountant who performs the
engagement to express negative assurance regarding the reliability of those financial statements. At
the conclusion of a review engagement, an accountant will typically report that nothing came to his
or her attention to indicate that the information in the financial statements contained material
misstatements. In the current case, if Lore Levi expressed suspicions regarding Betty’s honesty to
Case 3.2 Howard Street Jewelers, Inc.
188
c. A compilation differs from an audit and a review in that the accountant performing the
engagement does not express any assurance on the financial statements in question. AR Section
100.02 states that a “compilation . . . is limited to assisting management (owners) in presenting
financial information without undertaking to obtain or provide any assurance that there are no
material modifications that should be made to that information.” However, AR 100.06 notes that
3. Small businesses often cannot implement extensive control activities due to resource constraints.
Particularly problematic for small businesses is an inability to achieve complete segregation of key
duties (custodianship, authorization, and recordkeeping) within each transaction cycle. To mitigate
the problems posed by limited resources available for control purposes, it is important for small
businesses to establish “compensating controls.” These controls typically require the active