Crazy Eddie

With different industry definitions and viewpoints, fraud can be a tough issue for audit committee members to grasp for oversight purposes. The legal obligations of audit committee members have intensified because their standard duty of care and loyalty to the entity has increased in light of management fraud activities.

The auditing firm Coopers & Lybrand was accused of failing to perform a proper GAAS audit. One strategy the auditors could have performed was to follow the trail of revenue vs expenses. The auditor should have notice large sums ($10 million) of revenue going into one particular expense (Suppliers/Inventory). Considering Phar-Mor filed that they lost money in fiscal year 1984 and 1985 and they never cleared

It is not possible for the auditor to be 100% certain that he/she has obtained all evidence regarding all significant related party transactions, especially if management is trying to conceal something. However, the

4. The auditors have the responsibility to search for related-party transactions because of materiality. AU 334 & AS 18 gives a standard for related parties that auditors have to perform during an audit. One way to search for related parties is to examine the transactions between different parties and trace to locate the customers and or suppliers. Another way to locate related parties is money that comes into the business from lenders and or borrowers. Audit procedures that should be applied by discussing with the BOD of any transactions that may be related, examine closely each account and to audit intercompany accounts.

There are various procedures that could be taken in to account that would, if properly implemented, would have detected the frauds that occurred within the companies. There are many control risks that should have been taking regarding inventory along with preliminary audit strategies for the inventory and substantive test to be done that would have raised many flags during the typical audits as well as in depth ones.

In the early 1980 the consumer electronics industry was growing at an explosive pace. Between the 1981 and 1984 the total sales for the industry doubled. To support increasing sales massive amounts of inventory has to be procured, marked up and sold to consumers. Inventory becomes the biggest asset a retailer has. As part of the audit planning processes the inspection of the inventory system and verification of the actual inventory numbers should have been a priority. Crazy Eddie was able to inflate its financial results by fraudulently altering its inventory counts and was able to conceal these activities from the auditors for several years.

2. Identify and briefly describe the specific fraud risk factors present during the 2000 NextCard audit. How should these factors have affected the planning and execution of the engagement?

The auditing firm has been in engagement with the company throughout the period when the fraud was being committed. One of the common and clear indicators of possible fraud was the company’s cash flow statement. The company experienced positive growth in its profits from the year 1996 through to the year 1998. However, a close analysis of the cash flow statement shows that the company had experienced negative figures of cash flow from both operating and investing activities and positive cash flow from financing activities which would not sufficiently offset the negative cash flows from operating and investing. It is therefore evident

As in the case with Enron, auditors didn’t do their jobs. In this case, the auditing company was Coopers&Lybrant. In order to realize the fraud, Mickey Monus and other had to put all their losses into expense accounts and come up with the way of boosting their asset accounts. They came up with an idea of inflating inventory. This wouldn’t be possible to do if Coopers&Lybrant wouldn’t do their job negligently. As video states, they were the lowest bid on Phar-Mor’s case, so they didn’t want to spend too much money on their audit. As a result, they checks only 4 stores out of 129. Moreover, they told Phar-Mor’s management in advance which stores will be checked.

B) I think the auditors should have equal responsibility for detecting material misstatements due to error and fraud. It’s their job to make sure the financial statements are as accurate as possible. Although it may be hard to check all the information from a company it’s the responsibility of the auditor to sign off that everything is in check.

“Audit committee members or their agents may proactively examine areas, functions, and personnel where collusive fraud risk is reasonably likely to be perpetrated,” (Zmags). The search for fraud, even if performed in the same location multiple times, may continue until the audit committee feels confident that they have ruled out the probability that fraud is prevalent. One of the biggest risks of fraud is management override of controls, requiring the extensive search for risk in, “journal entries and other adjustments and reviewing accounting estimates for possible biases that could result in material misstatements,” (Nysscpa).

2) Much of Crazy Eddie’s fraud can be attributed to the overstatement of inventory and the understatement on accounts payable, not to mention the vast number of executives who were involved in the scheme. Specific audit procedures, if performed, could have led to the detection of the following accounting irregularities:

2Arguments for why auditors should not be allowed to perform these services for the same client include:

6. Identify the accounting and auditing issue: (1) Crazy Eddie’s behavior of overstating year-end inventory is against GAAP requirements. (2)Management has the responsibility to fairly present financial statements in accordance with GAAP.

Following the risk assessment procedures, substantive procedures are designed and conducted to detect material misstatements of relevant assertions. Substantive procedures include analytical procedures and tests of details. Analytical procedures involve evaluations of financial statement information by a study of relationships among financial and nonfinancial data. Tests of details may be divided into three types. One test is the test of account balances to address whether there are misstatements in the ending balance of an account. In the case of Crazy Eddie, auditors should have put greater attention to inventory and accounts payable accounts. The second test is a test of classes of transactions to determine whether particular types of transactions have been properly accounted for during the period. Crazy Eddies fraudulently classified these transshipping transactions as retail sales to inflate its sales revenue and continue growth at existing stores. A key ratio for retailers is to compare growth in existing stores to growth from new stores. The third and final test is a test of disclosures to evaluate whether financial statement disclosures are properly presented. Crazy Eddie prepared bogus debit memos of over $20 million to understate accounts payable.