CASE 5.1
CARDILLO TRAVEL SYSTEMS, INC.
Synopsis
Auditors and accountants are frequently forced to resolve ethical dilemmas in their professional
roles. There is often a significant price to be paid by the accountant or auditor who chooses the
ethically “correct” resolution to such a dilemma. For instance, an auditor may lose a lucrative
engagement as a result of complying with the profession’s ethical principles. Of course, if an ethical
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Cardillo Travel Systems, Inc.—Key Facts
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1. During the early 1980s, Cardillo incurred significant operating losses even though it was
experiencing rapid growth in revenues as a result of Rognlien’s aggressive franchising strategy.
2. The court order outstanding against Cardillo required the company to maintain total stockholders’
equity of at least $3 million.
4. Recording the $203,000 United Airlines payment as commission revenue allowed Cardillo
management to maintain stockholders’ equity above $3 million.
6. The company’s controller refused to misrepresent the nature of the United Airlines payment
when pressured to do so by Rognlien.
7. The two audit engagement partners involved in this case refused to accept the incomplete and
8. In early 1986, Cardillo’s weak financial condition was made even worse by a $685,000 civil
judgment imposed on the company.
Instructional Objectives
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2. To illustrate the personal costs that accountants and auditors may be forced to absorb when they
behave ethically.
4. To emphasize the need for auditors not to accept incomplete or inadequate explanations from
client personnel for questionable transactions discovered during an audit.
Suggestions for Use
This case focuses upon ethical issues and is thus best suited for coverage during class discussion
of the AICPA Code of Professional Conduct. Unlike most cases investigated by the Securities and
Exchange Commission (SEC), in this case the federal agency found that the relevant accountants and
auditors had fulfilled their professional responsibilities—at some personal cost to themselves. I
Suggested Solutions to Case Questions
1. The three accountants in this case who faced ethical dilemmas were Russell Smith, Cardillo’s
controller, and the two audit engagement partners, Helen Shepherd and Roger Shlonsky. The
dilemma facing Smith was whether to violate his personal ethical norms of conduct as well as those
of his profession or to risk losing his job by refusing to cooperate with Rognlien. The dilemma
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stockholders and creditors received accurate information regarding the company‘s financial position
and results of operations. A firm’s creditors need such information to make informed credit-granting
and lending decisions. Corporate stockholders need such information so that they can determine
whether to retain or increase their ownership interests in a given firm.
2. According to AU Section 722, “Interim Financial Information,” an auditor should employ
primarily analytical procedures and inquiries of management when performing a review of a client‘s
interim financial statements. Listed next are examples of specific procedures that AU 722 suggests
auditors should consider applying when reviewing a client’s interim financial statements.
a. Inquiry of client management regarding the existence of any significant deficiencies,
including material weaknesses, in internal controls.
b. Use of analytical procedures to identify any unusual relationships in the interim
financial statements.
3. Following is the evidence collected by Touche Ross that supported the material accuracy of the
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$203,000 adjusting entry.
a. Lawrence’s initial representation that the adjusting entry was valid (made to the
Touche Ross auditors during their review of Cardillo’s 2nd quarter 10-Q).
Listed next is the evidence which suggested that the $203,000 adjusting entry was suspicious.
a. Shepherd’s review of information regarding the United Airlines-Cardillo agreement
that suggested the $203,000 was refundable to United Airlines under certain
conditions.
The third standard of fieldwork requires an auditor to obtain sufficient appropriate evidence to
support his/her opinion on a set of financial statements. The sufficiency of audit evidence is a matter
of professional judgment on the part of the auditor. That is, each auditor must decide when he/she
has collected sufficient (appropriate) evidence to support a decision regarding the fairness of an
account balance or the overall fairness of a set of financial statements. The professional standards
4. The principal objective of the 8-K auditor change disclosure rule is to inform financial statement
users of important contextual circumstances surrounding a change in auditors by a public company,
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for improper reasons. In fact, the 8-K auditor change disclosure rule was adopted by the SEC in the
1970s in response to widespread allegations of “opinion shopping” by public companies. According
to these allegations, when major technical disputes arose between auditors and client management
5. The AICPA’s quality control standards require CPA firms to establish policies and procedures
that minimize the likelihood of accepting a client that lacks integrity. Among the specific quality
control procedures that may be used by CPA firms when deciding whether or not to accept a
prospective audit client are the following:
a. Inquire of the predecessor audit firm whether it has any reason to question the
integrity of the prospective client’s management.