Something went sour at Parmalat

The Italian dairy food corporation Parmalat SpA was founded by Calisto Tanzi in 1961 and grew to a global company. It had about 140 production centers, 36,000 employees and 5,000 contracted dairy farms (https://en.wikipedia.org/wiki/Parmalat). The dairy food giant defaulted on debt in November 2002 and filed bankruptcy in December 2003. It sounds ridiculous because Parmalat’s subsidiary in Cayman Islands had a $4.9 billion cash balance in Bank of America account. However, this account was falsified. Meanwhile, Parmalat also hid losses of $10 billion and increasing assets as high as $19 billion. The auditors did not show enough professional skeptism and due care during the audit.

1. What steps does an auditor ordinarily take when confirming cash balances held on deposits with financial institutions?

The auditors usually require a confirmation letter from the financial institution to check if the account balance of bank agrees with the numbers on the company’s books. Auditing standards require direct communication that mailing the confirmation letter to the bank be sent by the audit firm and responded directly to the firm in case of any change by client. The confirmation letter also should be received by mail with post stamp and original documents rather than the facsimile in the case.

If auditors believe the company’s internal control is not strong enough, they may: (1) trace the accounts to see whether the transactions are properly recorded; (2) vouch the company’s documents to make sure the transactions are authorized; (3) recalculate the cash balance to check if the outcome verifies the bank balance.

2. What additional steps should the auditors have taken when they received the smudged fax copy printed on Bank of America letterhead?

The auditors should apply their professional skeptism after receiving the