Question 2 (35 marks)

In 1890, the Brooklyn Trolley Dodgers professional baseball team joined the National League. Over the
following years, the Dodgers would have considerable difficulty competing with the other baseball teams
in the New York City area. Those teams, principal among them the New York Yankees, were much better
financed and generally stocked with players of higher calibre.
After nearly seven decades of mostly frustration on and off the baseball field, the Dodgers shocked the
sports world by moving to Los Angeles in 1958. Walter OMalley, the flamboyant owner of the Dodgers,
saw an opportunity to introduce professional baseball to the rapidly growing population of the West
Coast. More important, OMalley saw an opportunity to make his team more profitable. As an
inducement to the Dodgers, Los Angeles County purchased a goat farm located in Chavez Ravine, an
area two miles northwest of downtown Lost Angeles, and gave the property to OMalley for the site of
his new baseball stadium.
Since moving to Los Angeles, the Dodgers have been the envy of the baseball world: In everything from
profit to stadium maintenance the Dodgers are the prototype of how a franchise should be run.
During the 1980s and 1990s, the Dodgers reigned as the most profitable franchise in baseball with a pretax profit margin approaching 25 percent in many years. In late 1997, Peter OMalley, Walter OMalleys
son and the Dodgers principal owner, sold the franchise for $350 million to media mogul Rupert
Murdoch. A spokesman for Murdoch complimented the OMalley family for the longstanding success of
the Dodgers organization: The OMalleys have set a gold standard for franchise ownership.
During an interview before he sold the Dodgers, Peter OMalley attributed the success of his organization
to the experts he had retained in all functional areas: I dont have to be an expert on taxes, split-fingered
fastballs, or labour relations with our ushers. That talent is all available.
Edward Campos, a long time accountant for the Dodgers was seemingly perfect example of one of those
experts in the Dodgers organization. Campos accepted an entry-level position with the Dodgers as a
young man. By 1986, after almost two decades with the club he had worked his way up the employment
hierarchy to the operations payroll chief.
After taking charge of the Dodgers payroll department, Campos designed and implemented a new payroll
system, a system that only he fully understood. In fact, Campos controlled the system so completely that
he personally filled out the weekly payroll cards for each of the 400 employees of the Dodgers. Campos
was known not only for his work ethic but also for his loyalty to the club and its owners: The Dodgers
trusted him, and when he was on vacation, he even came back and did the payroll.
Unfortunately, the Dodgers trust in Campos was misplaced. Over a period of several years, Campos
embezzled several hundred thousand dollars from his employer. According to court records, Campos
padded the Dodgers payroll by adding fictitious employees to various departments in the organization.
In addition, Campos routinely inflated the number of hours worked by several employees and then split
the resulting overpayments 50-50 with those individuals.
The fraudulent scheme came unravelled when an appendicitis struck down Campos, forcing the Dodgers
controller to temporarily assume his responsibilities. While completing the payroll one week, the
controller noticed that several employees including ushers, security guards and ticket sales people, were
1

being paid unusually large amounts. In some cases, employees earning $7 an hour received weekly pay
cheques approaching $2,000. Following a criminal investigation and the filing of charges against Campos
and his cohorts, all the individuals involved in the payroll fraud confessed.
A state court sentenced Campos to eight years in prison and required him to make restitution of
approximately $132,000 to the Dodgers. Another of the conspirators also received a prison sentence.
The remaining individuals involved in the payroll scheme made restitution and were placed on probation.
Required:
1. What is your assessment of the control risk associated with the payroll cycle at the Dodgers and
why? [5 marks]
2. Given the control risk determined above what should the auditors have done in response [5
marks]
3. Identify the key audit accounts and the audit objectives associated with a clients payroll function.
Given the nature of the fraud what should have been the focus of the auditors objectives and
why? How do auditors normally test payroll provide some detail for each account involved? Why
might this not work given the fraud that occurred at the Dodgers? [10 marks]
4. What internal control weaknesses were evident in the Dodgers payroll system? [10 marks]
5. Identify audit procedures that might have led to the discovery of the fraudulent scheme
masterminded by Campos. [5 marks]
1.

What is your assessment of the control risk associated with the payroll cycle at the Dodgers and why?
CR should be assessed as high
Why - given the fact that one person had almost complete responsibility for the payroll function--with
very little accompanying accountability.

2.

Given the CR was assessed as high the auditor should have:

A
A
A
B
B
B
B
3.

Increase supervision of audit staff

Assign more experienced audit staff to this section of the engagement
Use less predictable audit procedures
Taylor the nature timing and extent of audit procedures
Nature better substantive procedures perhaps less analytical review
etc.
Timing not really relevant as test of payroll is done at year end (so no
marks awarded)
Extent - Increased substantive testing of payroll
Identify the key audit accounts and the audit objectives associated with a clients payroll function. Given the
nature of the fraud what should have been the focus of the auditors objectives and why? How do auditors
normally test payroll provide some detail for each account involved? Why might this not work given the fraud
that occurred at the Dodgers?
Key audit accounts
Key audit objectives
Given the nature of the fraud what

accrued payroll and payroll expense

Completeness
Existence (account balance-related) and occurrence [validity]

should have been the focus of the

auditors objectives?
Why?
How do
payroll?

auditors

normally

test

(transaction-related).
The expense in this case was overstated but the auditors were
looking for an understated expense.
Auditors normally use extensive analytical review to test
payroll.

expense

An auditor typically develops an expectation regarding the

payroll expense for a given period by reviewing the payroll
expense reported by the client in a comparable prior period and
by considering such factors as the most recent average employee
pay raise granted by the client.
expense
If the client's recorded payroll expense varies significantly from
the auditor's expectation, additional substantive tests will be
required to investigate this difference.
accrual
the auditor must first determine the length of time over which
payroll, both hourly and salaried, should have been accrued by
the client.
accrual
The auditor must determine whether the accrued payroll
expense reported by the client is reasonable given the length of
that time period.
Why might this not work given the AR usually helps to identify variances between period since this
fraud that occurred at the Dodgers?
fraud had been occurring over a number of year AR would not
be effective.

4.

The following internal control weaknesses were apparent in the Dodgers' payroll system:

item
1

I/C weakness
Too much control was placed in one person:
- Compos designed the system
- Compos was involved in the operation of the system

There was an apparent lack of periodic testing of the payroll transaction cycle
- If there had been testing, the fraudulent scheme should have been discovery

the lack of enforced vacations for key personnel Compos did not take vacations requiring
someone else to perform his duties

5.
1

2
3
4

Suggest audit tests that would be effective in discovering Compos fraud scheme.
Given the type of employees where the fraud occurred (ushers and guards), the cheques may have
been handed out to the workers rather than direct deposit. In this case, a surprise distribution of
payroll cheques for selected departments by the auditors might have resulted in unclaimed cheques
and thus discovery of Campos' fraud.
Audit testing either manual or computer-based (CAAT) of limits should have disclosed instances of
employees being paid for an excessive number of hours. (e.g. identify rates outside normal range of
$7 per hour, identify hours outside normal range, e.g. identify total payroll outside normal range)
Analytical procedures to assess the reasonableness of the Dodgers' periodic payroll expense by
department might have revealed that certain departments' payroll expenditures were "out of line."
Other appropriate techniques