1 Group 2A Elayne Concepcion Tania Garces Sarahy Pagan Cal Temp Services, Inc.Group 2AElayne ConcepcionTania GarcesSarahy Pagan
2 Accounting Issues GAAP - revenue and accounts receivable recognition CTS revenue recognition policiesOverstatement of accounts receivableOther balance sheet accountsImpact of adjustments
3 GAAP - Revenue Recognition Revenues – Inflows of assets resulting from providing a product or service to a customerREALIZATION PRINCIPLEThe earnings process is judged to be complete of virtually completeThere is reasonable certainty as to the collectibility of the asset to be received
4 GAAP - Accounts Receivable VALUEDat the original exchange price between the firm and the outside partyREPORTEDNet of cash discounts, sales returns, and allowances and uncollectible accountsThe amount of cash expected to be collected
5 CTS – Revenue Recognition Policies Revenues for engineering services are recognized upon completion (realization) of projects, which are less than a yearIn accordance with GAAP
6 Did they comply? …NO!!!! Example – Vortext, Inc. Recognized revenue on December 31, 2000 based on a REQUEST FOR A QUOTE.Did not even obtain a PO
7 Overstatement of accounts receivable As of December 31, 1999Overstated by $253,427As of December 31, 2000Overstated by $666,242
8 Other balance sheet accounts As of December 31, 1999No other changes required for 1999As of December 31, 2000Line of credit should be credited for $196,000 for the draws posted as payments on a receivable that was reversed upon our analysisAccounts Payable for $30,000 should be reinstated as it was closed against a false receivable as a credit memo.
9 Impact of Adjustments As of December 31, 1999 As of December 31, 2000 Pre-tax income was reduced from $43,436 to a loss of $209,991As of December 31, 2000Pre-tax income was reduced from $149,098 to a loss of $517,144
10 Litigation Consulting Engagement Issues Evidence of collateral reporting fraudApparent motives of managementDamage to Second Union
11 Evidence of collateral reporting fraud Pledged AR on a first line of credit with a local bank and later used the same asset as collateral with the line of credit with the Second Union BankObjection to the bank contacting major customers is a red flag indicator
12 Additional EvidenceRoberts admission upon bank pressure of providing the bank with information on accounts receivable that would not prove to be collectibleSignature on certification reports
13 Apparent motives of management Survive the defense industry downsizing in the late 1990’sKeep CTS afloatIncrease sales of large engineering projects and expand into other value-added services to achieve growthNeeded to establish a good banking relationship that would help them through this expansionMeet loan covenants
14 Damage to Second Union As of December 31, 1999 As of December 31, 2000 Savings on additional drafts made by CTS $786,200As of December 31, 2000Savings on additional drafts made by CTS $196,000
15 Auditing Issues Distinction between error & fraud Evaluation of management’s actionAuditor’s responsibilityRisk factors (red flags)M&S reliance on managementInformation availability
16 Error vs FraudError are unintentional misstatements or omission in financial statementsFraud, in contrast, arises form deceitful financial reporting and from misappropriation of assetsIntent is the primary difference between an error and a fraud
17 Evaluation of management’s action CTS committed fraudManagement’s intention was to deceive financial statement users, specifically Second UnionAltered records and documentsMisrepresenting transactions
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19 Auditor’s responsibility An audit is designed to obtain reasonable assurance about material misstatementsDoes not impose a legal obligation to detect cleverly concealed fraudAuditors are responsible to assess the likelihood of fraud in every auditDesign tests that would provide reasonable assurance of detection
20 Risk factors Aging of accounts receivable Continual increase in accounts receivableFrequent overdrafts on the CTS checking accountRepeatedly issued credit memos for older invoicesConflicting or missing evidence
21 M&S reliance on management Professionally skeptical of management, rather than assume unilaterally that management has integritySubsequent collections is not an adequate confirmation by itselfTraced deposits to copy of customers checks kept on filesAttention should also being paid for credits given on accounts receivable
22 Information availability Collection problem or a softening of the credit requirementsProblems with cash flowsRiskier line of credit
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