Problem
Slick Industries (SI) is an exchange traded company that operates 300 stores in the hyper-competitive retail market. To compete with companies like Wal-Mart and Target, it lowered prices below cost to attract customers and stimulate growth. While that strategy drove sales revenue up significantly, SI was incurring significant losses because it was selling goods for less than it had paid for them. The President of SI, Sam Shyster, told the investing community that SI's secretive "power buying" strategy enabled it to beat its larger rivals on pricing. Meanwhile, Shyster was hoping that company growth in sales revenue and opening new stores would enable SI to get large enough to sell its way out of trouble. To hide the losses, Shyster pressured the CFO to keep two sets of books-one for the auditors and one that reflected the truth.
To accomplish its plan for survival and growth, SI would dump losses into a "bucket account" and then reallocate the losses to one of the company's 300 stores in the form of increases in inventory costs. SI issued fake invoices for merchandise purchases, made phony journal entries to increase inventory and decrease cost of sales, recognized inventory purchases but failed to accrue a liability, and over-counted merchandise.
The CFO was able to conceal the inventory shortages because the auditor (PKD, CPAs) observed inventory in only four stores out of 300 and they informed SI months in advance which stores they would visit. SI management would fully stock the four selected stores but allocated the phony inventory increases to the other 296 stores.
Task
Answer the following questions:
A. Did PKD violate PCAOB or AICPA audit standards in the manner in which they conducted the inventory audit?
B. Provide authoritative citations and reasoning to support your answer in (A) above.
C. What inventory audit step, aside from analytical review steps, might have helped PKD catch the manipulation of inventory?