Guidance on Auditing High-Risk Clients

Jill M. D'Aquila, PhD, CPA, and Kim Capriotti, PhD, and Robert Boylan, PhD, CPA, and Ruth O'Keefe, JD, MBA, CPA

Several years ago, Ernst & Young believed it would be wise to identify its riskiest clients in light of recent well-publicized financial reporting scandals. Accordingly, the firm identified Bally Total Fitness Holding Corp. as one of 18 “national focus accounts” that should be monitored by its Americas Executive Board. It identified Bally as the riskiest account in the Lake Michigan area, particularly finding that Bally's management was difficult and engaged in aggressive accounting. Ernst & Young considered resigning from the Bally account due to these risk issues. At a meeting, the partners involved with this engagement prepared a list indicating reasons for and against resignation, and they discussed Ernst & Young's exposure. At the heart was Bally's accelerated recording of revenue related to reactivating expired customer memberships. Interestingly, Arthur Andersen partners had a similar meeting in February 2001 when they contemplated whether to retain Enron as a client, given the high degree of engagement risk.