Cuttington University

Suakoko, Bong County

Auditing II Assignment #1

Presented to: Mr. Kamara

Presented by: Amos N. Sando’

ID: 28215

Date: March 10, 2011

Summary of the Crazy Eddie Case

Crazy Eddie Inc. was a retail consumer electronics store in New York City. By
1987, Crazy Eddie Inc. had 43 retail outlets, sales exceeding $350million,
and outstanding stock with a collective market value of $600 million.
Doubling in the four-year period from 1981 to 1984, sales in the consumer
electronics industry exploded. Eddie Antar, the owner of the Crazy Eddie, Inc.
converted his stores into consumer electronics supermarkets. Antar stocked
the shelves of Crazy Eddie's retail outlets with every electronic gadget he
could find and with as many different brands of those products as possible.
At its peak, Crazy Eddie had 43 stores in the chain, and earned more than
$300 million in sales with DJ Jerry Carroll its main advertiser on radio and TV
shows.

In February 1987, the U.S. Attorney for the District of New Jersey
commenced a federal grand jury investigation into the warranty billing
practices of Crazy Eddie. In September of that year, the United States
Securities and Exchange Commission initiated an investigation into alleged
violations of federal securities laws by certain Crazy Eddie officers and
employees. Eddie Antar was eventually charged with a series of crimes was
indicted.

Unable to sustain his fraudulent business practices, Eddie Antar cashed in

millions of dollars worth of stock and resigned from the company in
December 1986. Crazy Eddie's board of directors lost control of the company
in November 1987 after a proxy battle with a group led by Elias Zinn and
Victor Palmieri, known as the Oppenheimer-Palmieri Group. The entire Antar
family was immediately removed from the business. The new owners quickly
discovered the true extent of the Antar family's fraud, but were unable to
turn around Crazy Eddie's quickly declining fortunes. In 1989, the company
declared bankruptcy and was liquidated. Crazy Eddie became a known
symbol for corporate fraud in its time, but has since been eclipsed by the
Enron, Worldcom and Bernie Madoff accounting scandals.

Antar fled to Israel in February 1990, but was returned to the United States
in January 1993 to stand trial. His 1993 conviction on fraud charges was
overturned, but he eventually pleaded guilty in 1996. In 1997, Antar was
sentenced to eight years in prison and paid large fines. He was released from
prison in 1999.
Questions and Answers

1. Compute key ratios and other financial measures for Crazy Eddie
during the period 1984-1987. Identify and briefly explain the red flags
in Crazy Eddie’s financial statements that suggested the firm posed a
higher-than-normal level of audit risk.

Ans.: Key Ratios: 1987, 1986, 1985, 1984

Liquidity Ratios:
Current Ratio: 2.4062, 1.3985, 1.5626, 0.9287
Quick Ratio: 1.4044, 0.5982, 0.7680, 0.1499

Solvency Ratios:
Debt to Assets Ratio 0.6837 0.6643 0.6359 0.8298
Times Interest Earned 3.6169 30.3927 28.2877 14.9253
Long-Term Debt to Equity 2.1617 1.9786 1.7462 4.8755

Activity Ratios:
Accounts Receivable Turnover 32.5026, 116.7711 49.7515, 52.7208
Inventory Turnover Ratio: 4.98, 3.55, 1.89, 1.95

An analysis of key ratios during the period of 1984-1987 would have

resulted in red flags that indicated that Crazy Eddie had a higher than
normal level of audit risk. For instance the inventory turnover decreased
from 4.98 to 1.95. There is also a problem with accounts receivable, the age
increased from 3.4 days to 6.7 days. It is important to move electronics in
the inventory fast because the technology gets obsolete quickly. Crazy Eddie
was facing increased competition and market saturation yet still managed to
increase profits. The inventory ratios verified that there was a problem with
the accounting at Crazy Eddie.

2. Identify specific audit procedures that might have led to the detection
of the following accounting irregularities perpetrated by Crazy Eddie
personnel:

a. The falsification of inventory count sheets

ans.: Visit the stores without prior acknowledgement of it and
 check the inventory in place to detect the falsification of
inventory count sheets.

b. The bogus debit memos for accounts payable

ans.: Contact the vendors, suppliers, creditors, etc. to verify that
payment information or check their IRS records to detect the
bogus debit also confirm notes payable with banks and creditors,
then trace information in the confirmation replies to the general
ledger.

c. The recording of transshipping transactions as retail sales

ans.: (Observation) View recorded sales from authorized
shipping and approve customer orders and send monthly
statements to customers. Segregate duties between handling
cash and record keeping and independent reconciliation of bank
accounts. This provides separate, independent verification of the
cash receipts and enhances proper application of such receipts
to the appropriate accounts.

d. The inclusion of consigned merchandise in year-end inventory.

ans.: (documentation) Use of an adequate chart of accounts
and internal verification of classification will assist in proper
classification. Also tracing backwards from items in the inventory
to vendor's invoices to the recording reports and paid checks.

3. The retail consumer electronics industry was undergoing rapid and

dramatic changes during the 1980’s. Discuss how changes in an audit
client’s industry should affect audit planning decisions. Relate this
discussion to Crazy Eddie.
Ans.: The industry underwent rapid and dramatic changes during the
1980’s thereby ushering more competitors for Crazy Eddie Inc. As a
result all of the firms in this industry may like to meet profitability
goals. As such they may be forced to cook the books in order to meet
their objectives in attracting potential investors. This is what happen to
Crazy Eddie when its CEO Eddie Antar instructed his workers to
overstate their inventory by 2millions resulting in the increment of
profit by the same amount. Therefore in such cases, auditors must
thoroughly plan the auditor to detect these irregularities by the firms.
4. Explain what is implied by the term lowballing in an audit context. How these
practices potentially affect the quality of independent audit services?
Ans.: Lowballing means soliciting services far below generally accepted
market price to stave off competitor's bid for the same services to
perspective clients. The scope of the audit would not be reflective and narrow
in this situation. The audit might also be understaffed because due to the
inability to charge over stated rate in engagement. Also there might not be
enough money to do thorough and proper procedures in the audit this may
impair audit independence

5. Assume that you were a member of the Crazy Eddie audit team in 1986. You
were assigned to test the client’s year-end inventory cutoff procedures. You
selected 30 invoices entered in the accounting records near year-end: 15 in
the few days prior to the client’s fiscal year-end and 15 in the first few days
of the New Year. Assume that client personnel were unable to locate 10 of
these invoices. How should you and your superiors have responded to this
situation? Explain.
Ans.: We will try to locate alternative evidence, like delivery notes
acknowledged by customers; van drivers' log books to see which customers
they've recently delivered goods to. Also, use other procedures like analytical
procedures (e.g. compare GP ratio for this year and last year).

6. Should companies be allowed to hire individuals who formerly served as their

independent auditors? Discuss the pros and cons of this practice.
Ans.: No, companies should not be allowed to hire individuals who formerly
audited them based on auditing standards. When companies hire individuals
who formerly serve as their independent auditors, the auditor can more
easily conceal fraudulent activities during the course of subsequent audit
because a former auditor may help his or her new employer undermine
subsequent audit. On the other hand it may be necessary for him/her to be
hired because he/she had worked with a more prestigious accounting firm
and had a nationwide accounting practice with several prominent clients. This
may enable their firm to increase the public’s confidence in the company’s
financial statement.