Case

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Case 6-Phar-Mor, Inc.
Avoid Associating With High-Risk Client
(i.e., Minimize Inherent Risk)
Firms should follow quality control guidelines as set
forth in the professional standards (TIC PIE
CPA/DOE). These include correct hiring, development,
supervision and advancement practices, peer and
quality reviews, partner rotation, consultation on
difficult matters with other partners, and appropriate
attention to auditor independence.
The response of Coopers & Lybrand following the
Phar-Mor litigation is useful in answering how firms
can reduce the likelihood of being associated with
management fraud and resulting litigation. These
methods have been carried over to the merged firm
PricewaterhouseCoopers (PwC).
The Firm has a firm-wide department of risk
management. All new clients with risk factors must be
approved by this department prior to acceptance,
preferably prior to the proposal. One major advantage
of using this approval system is that the client
acceptance decision is more objective. In the late 1980s,
25 percent of the clients the Firm accepted had
experienced problems with the previous auditor. By the
mid 1990s, that percentage was down to four percent.
 Partners are continuously reminded they are not
alone. Difficult matters should be discussed with
other partners at the local and national levels.
 Each year the Firm identifies the 200 highest risk
continuing clients. These engagements go through
intense scrutiny as the firm challenges whether the
client should be retained. The Firm has “fired”
several high-risk clients in the last few years.
Partners are taught that it is cause for celebration
when they lose a “bad” client.
 The Firm’s engagement planning process
specifically identifies factors that might indicate
incentive, or the existence of management fraud.
 Based on a study of auditor litigation, the Firm has
found that 85 percent of lawsuits against auditors
are initiated when the client company fails.
Therefore, the Firm runs prospective and
continuing clients through viability screens
including sophisticated quantitative failure
prediction models. In addition to the quantitative
measures, the Firm considers several qualitative
factors such as industry risk, company risk,
management risk, corporate governance, oversight
risk, etc.
 The Firm studies the personality factors of the
client and the engagement team to ensure a proper
match. The Firm has found that most audit
failures have resulted because partner objectivity is
compromised. With this in mind, they conducted
studies of partners who have been highly successful
as well as those who have had problems with
former audits to begin to understand the warning
signs. They now monitor more closely partner
traits and situations that may compromise
objectivity.
 When necessary, the Firm provides objectivity
counseling to the auditors. For example, an audit
team may need counseling before an audit of a
high-risk client that has aggressive and
domineering management.
 The Firm demands better documentation of audit
decisions. They have found they can defend
decisions that are written in the working papers
easier than they can defend auditors’ recollections
stated years after the fact.
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