Cendant was formed on December 18, 1997, via the merger of CUC International and HFS, Inc. The company owns the rights to franchises and brands including Avis, Century 21 Real Estate, Coldwell Banker, Days Inn, Howard Johnson, and Ramada. The consolidated entity got off to a bad start when it was revealed that CUC International executives had been committing “widespread and systemic” accounting fraud with intent to deceive investors. When the company announced that it had discovered “potential accounting irregularities” the stock dropped from $36 to $19 per share. Eventually the stock would fall to as low as $6 per share as the company struggled to convince investors about management"s integrity. According to the company"s own investigation, CUC executives had inflated earnings by over $650 million over a three-year period using several tactics, including: (1) failing to timely record returned credit card purchases and membership cancellations, (2) improperly capitalizing and amortizing expenses related to attracting new members, and (3) recording fictitious sales.
Required:
a. For each of three fraudulent tactics employed by CUC, identify an analysis technique that could have identified the accounting improprieties.
b. Both the investors and the management of HFS had relied on audited financial statements in making decisions regarding CUC International. What do you believe was the external auditor"s culpability in not detecting these fraudulent practices?
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