The Red Flags In Crazy Eddie's Financial Statements

The red flags in Crazy Eddie’s financial statements that suggested the firm posed a higher-than- normal audit risk include cash balance, inventories, and accounts payable. There was a drastic increase in the cash balance in 1985 from the cash balance in 1984 and it dropped in 1986 and 1987. This suggest that company did not leave much cash to operate. Inventories on hand increased from 1984-1987. Inventory turnover ratio dropped from 4.50 in 1986 to 3.22 in 1987. Days to sell inventory increased from 81.11 days in 1986 to 113.35 days in 1987. Company’s accounts payable and short-term debt had a huge increase from 1984 to 1987.

2. Audit procedures that could have led to the detection of the following accounting irregularities perpetrated by Crazy Eddie:
a. Falsification of inventory count sheets: This could have been prevented if auditors observed physical inventory counts at the stores and if auditors would have performed random inventory count.
b. The bogus debit memos for accounts payable: The auditors could have confirmed account balances with vendors.
c. The recording of transshipping transactions as retail sales: Auditors could have observe transshipping transaction records and receipt for large sales with high dollar amount to make sure it was transshipping transactions and not retail sales.
d. The inclusion of consigned merchandise in
The retail consumer electronics industry was undergoing rapid and dramatic changes during the 1980s. Crazy Eddie’s inventory was overvalued due to constant improvements in technology, which caused prices of electronics to decline. Due to the constant improvement, electronics were becoming outdated and stores needed to have high inventory turnover ratio. Crazy Eddie became a transhipper because they were able to buy electronics in large amounts and at lower prices. The transshipping required special attention from auditors because it affected sales but not inventory. Crazy Eddie recorded transshipping sales as