As a retail store, inventory should have the biggest amount in current assets category. There would be no sales and no income if there was not inventory. In 1987, inventory was only the second largest asset of the company, while the short-term investment was the largest. Also, Crazy Eddie's inventory increased dramatically over the 1985-1987 period from 26 million to 109 million. Most of ratios had big change from 1986 to 1987. The return on equity ratio stated the rate of return on the ownership interest of the common stock owners. It decreased 60% in one year.
Also, the age of inventory had 40% increase, which means the inventories were taking longer to be sold. At the same time, with the increasing amount of total assets and inventory, the net income didn't go up much. Therefore, the return on total assets also decreased 60%. As an electronics retail store, inventory turnover and age of inventory ratios are fairly important. In 1987, inventory turnover dropped around 28%, while the age of inventory increased 39. 6%. The increase and decrease of ratios definitely raised red flags about company’s inventory or anything related to their inventory sales.
At the same time, as a retail store, its short-term investment to total assets ratio increased dramatically in 1987 from 21% to 41%. This increase should draw auditors’ attention on the short-investment business. 2. a) * Copy the worksheet of completion of physical check of inventory. * Record the sequence number on the tags during the physical check process. b) * Send A/P positive confirmation to selected sample accounts to confirm account balance. * Review related documents for payments received and determine if they are received from clients. ) * Review purchase order, sales invoice, bill of landing for retail transactions and verify if the financial statements are properly and accurately updated. * Perform tests on the sales cycle to see how well the system operates. d) * Review the procedure, which ensures the consigned merchandise is not included in the year-end inventory. 3. Auditors should have an understanding of the clients business and the market. The trend of market where client's business is at would be shown on client's financial reports.
Therefore auditors should be aware of the market change and modify the audit tests and procedures based on the market trend. By late 80s, there were several things going on in electronics retail industry. The demand for electronic products was decreasing, while competition was getting more intense. Both factors could have impact on Crazy Eddie's financial statements. Auditors should be aware of that with these negative impacts, client's management might attempt to inflate numbers shown on the statement to keep investors think positively. At the same time, client might lose the deals with its suppliers.
With the increasing risk, auditors need to modify their procedures to keep audit risk steady. 4. Lowballing is a method used by accounting firm to attract clients. The firm offers a comparatively low price to the client when compared with other accounting firms. In order to maximize its revenue, the accounting firm would have to lower the audit expense, and the audit quality would not be guaranteed. Also, if the audit firm ever found something wrong in client's financial statements and was about to issue a qualified opinion, they might face the risk of getting dismissed.
To keep this client, auditors might issue an unqualified opinion, when a qualified opinion was supposed to be issued. 5. First of all, I would enlarge the sample size and have the same test done. If the unlocated invoice ratio is still higher than the standard the audit team set, I would use another way to test the inventory cutoff procedure. If both ways did not lower the ratio, I would talk to my superiors and to figure out if they have deficiencies at the inventory cutoff procedure. 6.
Advantages: 1) Former auditors knows the employer's financial condition than other others, if the company has hired other people. Disadvantages: 1) Former auditors could help their new employer subvert the purpose of independence. SOX prohibits any executive members was employed by the registered independent public accounting firm and participated in any audit of the employer during 1-year period. 2) Quality of audit may go down due to the personal relationship between the former auditors and their former colleagues.